What am I missing?

Talks in New York with the unnamed banks are part of Insurance Superintendent Eric Dinallo’s effort to stabilize the bond guarantors and bolster the market’s finances, said agency spokesman Andrew Mais in an interview. Insurers MBIA Inc. gained 33 percent in New York trading and Ambac Financial Group Inc. soared 72 percent.

New capital may help preserve the top credit ratings for the bond guarantors such as MBIA, the industry’s largest, and halt any erosion of investor confidence in the $2.4 trillion of assets they guarantee. Ambac, MBIA’s biggest rival, lost its AAA grade from Fitch Ratings this month on concerns that losses tied to subprime mortgages may increase. *

Let me see if I’ve got this straight… Banks/financial institutions hold a lot of iffy CDOs (aka Big Shitpile/matryoshka lemons) – bundles of loans that likely contain sub-prime stuff that may default. They’ve covered themselves against the possibility of the loans going bad by buying insurance from monoline insurers (MBIA and Ambac are the ones in the news). Now, loans are going bad – it’s hitting the fan. The worry shifts to the insurers – how are they going to make good? Because folks are thinking that the MBIAs of the world aren’t going to be able to cover the CDO losses, their stock price tanks. Low stock price = even less capital in reserve at the insurers. If the monoline insurers go tango uniform (toes-up tits-up – de-bowdlerized by audience request), the balance sheets of the institutions holding the CDOs take awful hits. So, lets have the banks (some of whom have got to be holding the paper in question) bail out the people who are insuring them.

Seems a bit circular to me – my guess – only a matter of time before I, as a taxpayer, have the privilege of bailing out Wall Street…

Update – check the comments if you are interested in the topic. Prof. Kleiman replies to my email query:

…if the monolines’ guarantees are seen to be worthless, the shitpile grows. (I love “matryoshka lemons,” by the way.) And they could suffer from a kind of “run on the bank” even if they’re actually solvent. So it’s possible that pumping more equity capital in would actually stabilize the situtation, whether it’s the banks’ capital or someone else’s. But the banks have an especially strong reason to want to stanch the bleeding.

2 thoughts on “What am I missing?

  1. Tricky. With the caveat that I Am Not An Accountant, I think the banks minimally would enjoy a delay of reckoning from the deal, and there’s a prospect that it Might Even Work. The pessimist in me thinks this umbrella doesn’t look sized for the falling anvil, but what do I know? The Might Even Work dimension creates the prospect, however remote, that the losses *won’t* be socialized.

    I don’t know that it matters so much whether the capital comes from the insured banks or elsewhere. The result may be a form of self-insurance, but that’s not objectionable in principle. One real problem, at least according to an FT article on the subject, is that the banks have capital adequacy issues of their own.

  2. It’s scary that we still don’t have a good sense of the size of the anvil. Part of that may be that the anvil will shrink or (more likely) grow as conditions change – recession = more defaults, I’d posit.

    I’m trying to think through the self-insurance concept – hindered by the fact that I too Am Not An Accountant. I think a line from your FT article is a piece of it: “The banks also still feel stung after a failed bail-out plan backed by the US Treasury under which they would have bought assets from structured investment vehicles, known as SIVs.” Hmmm… Seems like banks that have the capital aren’t exposed, and those that need the insurance don’t have the money… Time will tell.

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