MBIA, Ambac Tumble, Default Risk Soars After Losses (Update3)

Source: Bloomberg

Jan. 17 (Bloomberg) -- MBIA Inc. and Ambac Financial Group Inc., battered by losses from the collapse of the subprime mortgage market, fell the most ever in New York Stock Exchange trading on concern they will lose their AAA credit ratings.

New York-based Ambac dropped 52 percent and Armonk, New York-based MBIA fell 31 percent as Moody's Investors Service and Standard & Poor's increased their scrutiny of bond insurers. Credit-default swaps on both guarantors rose to records, signifying investors see a growing chance that the companies won't be able to pay their debt.
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Ambac, which yesterday cut its dividend and ousted its chief executive officer after reporting greater-than-expected writedowns on the bonds it insures, said the Moody's decision was ``surprising.'' Losing the AAA stamp would cripple the bond insurers and throw doubt on the ratings of $2.4 trillion of debt the industry guarantees, causing as much as $200 billion in losses, according to data compiled by Bloomberg.
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MBIA, down 87 percent in the past year, dropped $4.18 to $9.22. Ambac plunged $6.73 to $6.24 and has now fallen 93 percent in the past 12 months.

Read more: http://www.bloomberg.com/apps/news?pid=20601087&sid=afPiWbgEN8qU&refer=home

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From what I'm hearing (cf. the Stock Market Watch threads here), that new $200 billion in losses across the financial industry and its clients Bloomberg calculates is going to turn out to be a very large underestimate (because everyone else will suddenly find their ratings also lowered on account of it becoming known that they are, effectively, uninsured).

Check out this CNBC video to give you an idea of the forthcoming ructions: http://www.cnbc.com/id/15840232?video=624755222&play=1

roots. :hi:

ATM fees will jump to $10 per transaction, at the machine plus another $10 at your bank. Visa will begin charging BOTH the customer AND the vendor. Due dates will be changed without notice in an effort to raise late fees. The penalty for being late on payments will jump to double, and the interest rate on your account will explode into the 40% range. It's all coming... they have to recover the money somehow.

There is only so much they can pass on to the customer without serious risk to their own interests. Of course, if it wouldn't hurt their interests they would do what you say....however, such actions could rebound. Defaults of credit cards, car loans, mortgages, personal loans will skyrocket, if they push to far.

Only so much blood you can squeeze from a stone.

When these bond insurers lose their AAA ratings so do the bonds these companies insure-- $2.4 TRILLION worth.

And when they become unable to function as insurers because there are simply no more reserves....

Something big and bad this way comes.

MBIA a 71 percent chance the company will default in the next five years, according to a JPMorgan Chase & Co. valuation model. In the case of New York-based Ambac, credit-default swaps show the odds are 73 percent.
http://www.bloomberg.com/apps/news?pid=20601087&sid=a4Z2bVBRM0G4&refer=home

Failure of confidence is infectious. So a strong, well-managed muni bond will be hit because the insurer fails. The phrase "guilt by association" applies here.

"Closely watched bond guru Bill Gross of Pacific Investment Management calls banks' participation in the CDS market a ponzi scheme..."

:banghead:

This loss of credit worthiness could put the Big Banks underwater. When a bank holds a bundle of loans that are shit and the guarantor is shit - then what you have is -ahem- shit.

If these funds are insured by the same agencies then they too are at risk. We have seen in recent months banks denying money market asset withdrawals. Depositors were royally pissed of course. This was, I believe, at Northern Rock. I am not sure how this scenario would play out in the U.S.

http://www.usatoday.com/money/industries/banking/2007-11-13-bank-america-writedowns_N.htm

http://online.wsj.com/article/SB118661509601392327.html

I'm safely thinking that a big shitstorm is heading our way.

because a lot of the funny securities -- CDO, CMO, etc. took out insure policies to cover against the crap that was packaged inside them.

The mortgage industry will go down further... and so will corporate bonds.

Everyone should see this.

Julie

I need some Tums

I don't like the sound of this at all.....very scary.

NEW YORK (MarketWatch) -- In a reversal, Ambac Financial Group Inc. thought better of pursuing plans to raise about $1 billion, citing Friday current market conditions and uncertainty that any new capital would secure its AAA credit rating.

.......

Bond insurers agree to pay principal and interest when due in a timely manner in the event of a default -- a $2.3 trillion business that offers a credit-rating boost to municipalities and other issuers that don't have AAA ratings. Without those top ratings, insurers' business models may be imperiled.

Moody's said it may take action after Ambac unveiled a $5.4 billion mark-to-market loss on its portfolio of credit derivatives. Roughly $1.1 billion of that comes from actual losses that Ambac expects from guaranteeing complex mortgage-related securities known as collateralized debt obligations, or CDOs.

http://custom.marketwatch.com/custom/myway-com/news-story.asp?guid={47B1344A-439F-4120-80C9-A28416D5CF9F}

It feels almost tangible

And, ugly.

Consequences.

Too bad none of the experts wanted to treat it as a serious issue.

Bank failures will be analgous the the S&L failures in the 80's. And they will fail for similar reasons-if I am understanding this right.

The S&L collapse took out only a small segment of the financial industry, and the US economy was far more resilient. The collapse in progress will take out large swaths of the financial industry, and we have a hollow economy, one which in recent years has been largely based on the various machinations of the financial sector -- in recent years we've manufactured little of global economic significance other than shady financial paper.

The S&L collapse was a blip. This is an economic nuclear bomb.

what this will mean for us? Does this mean whatever we have in a savings account will no longer be insured? I think I understand that cc companies will be trying to pass on their losses to the customer. (Luckily, we got out of cc debt a couple of years ago.)

Anyway, anyone want to try to get my thick skull to understand this?

Thanks.

not to be selfish, but how do I gauge the danger to my own savings, my IRA my 401k, all the shit I've been working for?

AND, if I understand what I'm reading... if you have a regular bank/credit union "FDIC insured" savings account, no, this won't affect it.

However, if you have your savings in a non-bank "money market" account, as many people do (for better returns than banks), then it might. It depends on what the money market fund has invested in.

Here's what I *think* the OP means: The bond insurers whose credit ratings are under review insure bonds from many sources... cities, states, corporations, etc. They don't actually hold the bonds, they just insure that the people who *do* hold the bonds won't lose money if the borrowers (the aforementioned cities, states, corps, etc) default on the bond. The entities that actually "hold" the bonds are banks, mutual funds and the like--including some money market funds, some pension funds, just about anybody who buys a piece of "bonds" on the market.

So... all those bond holders had the value of their "holdings" based on the fact that they were "insured" so they weren't likely to lose money. Now the rating agencies are looking at lowering the credit ratings of the insurers, meaning the bonds held by those entities are suddenly a lot more risky, because there's a possibility that the "insurance companies" (MBIA, Ambac) might not be able to pay up if the original borrower defaults.

Clear as mud, but not half as much fun.

**edit: typos and bad spelling also don't help clarify matters!**

Just because a bond has its rating lowered - say from AAA to AA ie: 1 rating position change, it does not mean that the issuer is less likely to make timely payments of interest. What it means to the bond holder, be it an individual, a Pension Fund, a Bank or a Mutual Fund is that the traders will more than likely value the bond at a lower price, thus affecting the overall value of a given portfolio.

It DOES NOT MEAN that the issuer is all of the sudden going to stop making interest payments when they are due or that they will default at maturity (not pay the principal back).

The only point you made that I might differ with is the statement "meaning the bonds held by those entities are suddenly a lot more risky". That is possibly going to be the case in certain circumstances but for the most part, we aren't talking about all bonds suddenly going from having a AAA rating to B - from premium investment grade to speculative. That just is not going to happen. The creditworthiness of the various issuers are not really going to be damaged by this, what is damaged is the PERCEPTION that the insurers (AMBAC & MBIA) will be there no matter what to shore up an issue should a default be threatened.


Bond traders price bonds based on a number of factors, among them supply and demand, interest or "coupon" rate of a given bond, its number of years to maturity, the likelihood of it being called in by the issuer (if it has a "call provision" - many, many bonds of any length have such provisions) prior to maturity and the credit rating/worthiness of the issuer, what the various Treasury's are paying, what the LIBOR is, and other things.

For example, lets say you hold an A rated bond that has ten years to maturity issued by an organization that has recently announced it is in a tenuous financial position. The rating agencies might lower the credit rating of the issuer to BBB from A. That move would almost certainly force the price of the bond down. The traders will see that as an additional risk element and would demand a higher yield for the perceived risk. Remember, the lower the bond price, the higher the yield and vice versa. So what happens? If you had bought the bond at Par ($1000) your bond might now have a market value of $975. Your portfolio statement now shows a $25 loss on the position. But if you continue to hold the bond, you will continue to receive your interest payments from the issuer all the way till it matures and then you will get your thousand dollars back. There is no harm and no foul.

Lets say you are a Bond Fund manager or a Pension Fund manager and you want only "A" rated bonds or better in your portfolio. You are adamant about this and you will not buy any bonds lower than an A rating and you will sell off any bonds that fall below that rating. In the above scenario, you are going to sell the bond off for a $25.00 loss.

THAT would be a realized loss. The first scenario does not have a realized loss because you held the bond all the way to maturity.


This whole thing is seen as a big deal because bonds are viewed as a safe haven. We have all heard the line "Flight to quality" or "flight to safety". Going from equities to bonds ensures a stream of income and avoids the falling prices of equities. If the perceived creditworthiness or quality of a bond is in doubt, it throws a monkey wrench into the works. Traders like to know whats going on. Uncertainty and surprises are enjoyed by no one. If you are buying a large chunk of something that has a value that everyone has agreed on up till now and it all of the sudden changes, no one likes it. As I mentioned above, bond prices can fluctuate, so this is not a game for the timid or the uninformed. You can lose your shirt in the bond market just as you can in equities.

It is important to keep this little bit of perspective regarding these Bond Insurers. The likelihood of them EVER having to cover every single bond they insure all at once is beyond minuscule. It is the same likelihood that State Farm or New York Life will have to honor every single policy they have in force all at once.

Point taken. So what I *should* have said is that "the bonds held by those entities suddenly *SEEM* more risky." I.e., the underlying bond is no more risky today than it was yesterday, there's just suddenly uncertainty about whether, IF the issuer defaults, the insurer will be able to "cover" the bond, right?



This is another point I keep losing track of... the insurers insure *thousands* of bonds (or, at least hundreds). If only one defaults, they're not going to have a problem covering it, even if their credit rating goes to sh*t. It's only if a large number of the issuers default... in a really bad economy, that *might* happen, but even with our current problems, I don't think it's all that likely that it *will* happen.

But then, what do I know? I'm not only not an expert, I'm not even a talented amateur when it comes to economic and financial matters. My "financial motto" is, don't take chances if you don't have to. If you do have to, take the smallest risk you possibly can. It won't make me rich. It might even make me a little poorer (after inflation)... but it's unlikely to make me destitute, and that's all I'm aiming for right now.

The use of the word "seem" is all too important. If there is even the slightest perception of an increase in risk, if it SEEMS as if there is now a possibility a default will not be covered, it will affect how the bonds are priced by traders.

And yes, between MBIA, AMBAC and the others, the dollar amount they insure on the municipal side alone is mind boggling. It is most certainly in the thousands of issues, tens of thousands even and they add up to almost Two Trillion dollars nationally. Think of how many projects are going on or have been completed in the last few years in just your area.

Roads repaved? Bond issue.
School built? Bond issue.
Sewer line installed? Bond issue.
New waste water treatment plant? Bond issue.
Highway overpass? Bond Issue.
Airport improved? Bond Issue.

Etc, etc, etc, etc,

"how the bonds are priced by traders."

In your original reply, you pointed out that if the bond holder doesn't sell the bond, and the issuer doesn't default, there's no "cost" at all. It's only if the bond holder decides to SELL the bond (due to a downgrade in rating) that the "market price" comes into play. Unfortunately, the most conservative holders--pension funds, for example--are more likely to HAVE to sell due to their guidelines... from your example:



I know that many pension funds, and some money market mutual funds *require* their managers to sell any investment that drops below whatever they determine a "safe" rating is. So, the people most likely to be hit with a realized loss (or as I think of it, a *real* loss instead of a paper one), are the people who have their money in funds that are supposed to be super-safe. They're considered "super safe" BECAUSE they don't have investments lower than that pre-determined "safe" rating.

And, if I understand correctly, if they put out the promise (prospectus) that they won't hold investments below a certain rating, and they continue to hold bonds (or any other investment) that drops below that rating, they can be sued, right?

Oy.

Take my hypothetical example from my earlier post;

If that bond is sold for the $25 loss, it is going to affect the NAV of the fund (if it was held in a Mutual Fund) or it simply lowers the dollar amount on the asset side of the balance sheet in the case of a Pension Fund. Of course, the likes of a major Bond fund like American Funds Bond Fund of America or any of the well known Pimco bond funds are not holding one single $1000 par bond. They are buying and holding $10,000,000 or more of a particular issue. If a ten million dollar position takes a 2.5% valuation hit, we are no longer talking peanuts.

Many people might not be aware that bonds typically trade with "accrued interest". This is an important thing to keep in mind when contemplating this entire scenario. Here's how that works;

The ABC company issues 5% coupon bonds. The bonds pay their interest payments twice a year - say January and June (it is almost always 6 months apart, but quarterly pay bonds do exist). The bonds have a ten year maturity and were issued 18 months ago. The "Bain_sidhe & Heretic Bond Fund" (hee hee) purchases $1,000,000 face value of these bonds. We get 1,000 - $1000 bonds. But we buy them on the 10th of March. Now the previous holder received his last interest payment in January and has held them until the day he sells them to our fund. HE IS ENTITLED TO THE INTEREST accrued since his last payment and WE HAVE TO PAY HIM THAT INTEREST when we buy the bond. We will get an entire 6 months worth paid to us in June, but we have to pay the guy what he is entitled to receive.

Lets say for simplicity's sake that we bought the bonds at par. The bonds are well rated and if we hold them only until the next interest payment, we stand to gain $25,000 (one million times .05 divided by 2) and we could turn around and sell them the day after receiving that interest payment for par. What happens if in the meantime this downgrade occurs and now any new buyer will only pay $975 for them? That is our entire interest payment gone up in smoke. If we can't even get $975 for them, we're screwed. We are going to most definitely lose money if we sell now and we are left with three choices: 1) Hope we can find a trader that will give us closer to par for them, 2) hold them until we have received enough interest payments that we can recoup our million or 3) wait until they mature. It is a natural function of the bond market that as a bond gets closer to maturity, the closer to par it will trade, so we have that to look forward to. But like I said, these hypothetical bonds have 8.5 years to maturity. We're screwed.

That is, very simplistically, what the danger is.

This same scenario is basically playing out in every Money Market fund and every Bond fund out there every day, all the time. But those guys are pretty smart, and while a few of them get greedy and get caught out in the wind, for the most part a low risk bond fund is fairly safe.

A tip for those that look at reports on bond funds is to look at the average credit and average "duration" of a bond funds portfolio, (speaking specifically of a high grade bond fund, not a high yield fund). These days I would look for average credit quality to be BBB and better and average duration no longer than about 5 years.

Money Market funds operate considerably different that the average Bond Mutual Fund because they concentrate on VERY short term instruments - usually holding them 90 days or less.

As far as a fund being sued if they violate their prospectus, I honestly do not know how such a thing is handled. One thing is for sure - if they don't do what they say they are going to do in the prospectus, they will likely lose investors so the incentive to keep things on the up and up is strong. The competition for the investment dollar is strong. There are hundreds of choices so doing the right thing is in the fund managers best interest.

I left to go out for dinner right after I posted the above and ten minutes later I realized I made an error.
So for the sake of accuracy, the following;


should have made it clear that if we paid him his accrued interest it is added to the price of the bonds. Again, for simplicity's sake, lets say we bought them with exactly 90 days interest due. The cost of the transaction would have been $1,012,500 (plus transaction fees). So we did NOT stand to actually gain $25,000. We would have received that much money for the June interest payment but we already dropped $12,500. So if we bought this million dollar order, held it for 91 days and sold again at par, we would make a profit of $12,500 less transaction fees.

It becomes even more apparent now that even a slight reduction in our selling price can dramatically affect the profitability.

I believe we are largely talking about further potential shocks to large and largely risk-taking 'players' in the market 'system'. Heaven forbid that a widespread 'crisis of confidence', further runs on banks, S&L type bailouts at taxpayers' expense etc. should come to pass.

However, because of lack of efficient and effective regulation, these markets are surely more risky and potentially less resilient than in the now quite distant past.

I'm a European in Europe so I'm not very familiar with the options available through 401Ks and the rest, but I do opine that in the present climate for most 'ordinary people', in general (and we are talking about 'social security' and 'sustainable futures' at bottom here, aren't we?):

- great care should be taken to avoid avoidable risk and unnecessary debt;

- great attention should be paid to economic issues during your process of electing/selecting the best left-leaning Democratic candidate and while making sure that he or she of course wins the Presidency and goes on to appoint the right people in the right places and will encourage your democratic institutions to take the best possible decisions;

- economic systems should be considered to be intimately bound up with the need to address not only social but also environmental issues such as resource depletion, contamination and climate change.

I hope this helps.

Thank you.

Daddy bush took down the S&Ls, junior's taking the whole frickin' bond market. That amounts to multiple trillions...

When ratings by insurers go down, rates have to go up to cover risk spreads. Rates go up, prices go down, bondholders get caught by the short & curlies, and the whole world economy goes big ka-blooie!

Source: MarketWatch

SAN FRANCISCO (MarketWatch) -- Just when you thought it was over, trouble in the $2.3 trillion bond-insurance business could trigger another wave of big write-downs from banks and brokerage firms, experts said Friday.
Leading bond insurers Ambac Financial (ABK:AMBAC Inc

MBI 8.00, -1.22, -13.2%) look increasingly likely to lose their AAA ratings. While almost unthinkable just six months ago, such concerns are also causing turmoil in the $2.5 trillion municipal-bond market.

Bond insurers agree to pay principal and interest when due in a timely manner in the event of a default -- a $2.3 trillion business that offers a credit-rating boost to municipalities and other issuers that don't have AAA ratings. Without those top ratings, their business models may be imperiled.

If Ambac and MBIA lose their top ratings, billions of dollars of muni bonds will be downgraded, and the guarantees that have been sold on mortgage-related securities such as collateralized debt obligations, or CDOs, will lose value.

"The destruction of the bond insurers would likely bring write-downs at major banks and financial institutions that would put current write-downs to shame," Tamara Kravec, an analyst at Banc of America Securities, wrote in a note Friday.


Read more: http://www.marketwatch.com/news/story/bond-insurer-woes-may-trigger-more/story.aspx?guid=%7B590076D4%2DFB70%2D4304%2DB6B4%2DC444A554401C%7D

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A seat belt, sometimes called a safety belt, is a safety harness designed to secure the occupant

But it is not just Cramer. All day long the pundits kept saying that these insurers should not be allowed to go under and should be rescued. Of course meaning taxpayers picking up the tab.

"Gimme Gimme Gimme. And I want it now." It is all you hear Wall Streeters say.

... Wikipedia's entry for monoline insurance is pretty sparse, but it is bound to get much bigger. What began as a backwater guaranteeing boring, safe bonds issued by boring, safe municipal governments has branched out over the last few years to back all kinds of exciting new products - including those linked to sub-prime mortgages. Which is where the problems begin: this week the US bank Merrill Lynch knocked £1.5bn off its balance sheets because it could not rely on its monoline insurers to have the money. That is tantamount to pointing out that the safety net underneath financial markets has a socking great hole in it. Doubts have been raised over monolines for some time: shares in the sector are taking a battering, while credit-ratings agencies have warned that they could downgrade some of the firms. If that happens - and the Merrill Lynch statement is a bad omen - a large chunk of the £1.2 trillion of bonds they back will plunge in value. By how much? Some estimate that £100bn would immediately be wiped off markets.

Monolines are just one worry for policy-makers, who are sounding increasingly nervous. Yesterday President Bush called for a package of tax giveaways, worth at least £74bn, to kick-start the economy. The day before, Ben Bernanke, the head of the US central bank, suggested again that he would slash interest rates. The Bank of England has also begun cutting rates. As recognition of the need to prevent an economic downturn getting bigger than it need be, this is sound policy. But there are two big problems with cutting rates and taxes too far: one is that the US and the UK need a slowdown in consumer spending, but these measures could extend the borrowing binge. The second is that many of the biggest problems in financial markets require not macro- but micro-solutions. In other words, they need precise surgery, not just an industrial quantity of bandages. Start with monolines: one answer is for financial firms to be corralled into providing these vital insurers with emergency funding. The rescue attempts may be coordinated by regulators (as US central bankers led efforts in 1998 to clear away the bust hedge fund Long Term Capital Management), but must be funded privately. Regulators should also set guidelines on how banks disclose the losses they have racked up during the subprime crisis. As this newspaper has argued before, it is only by coming clean on the extent of their losses that banks will regain the necessary confidence to lend to each other again - and so ease the credit crunch.

Every market crisis exposes a deficit in regulation. This one is no different, and easily the biggest flaw it has revealed is a lack of cross-border supervision. A currently directionless International Monetary Fund could be beefed up to take on some of these powers, while national regulators should not only be given more oversight of their own banks; they should trade more information and be more willing to act in concert. Unless these solutions or others like them are brought in, that Wikipedia entry on the 2007 subprime crisis is likely to get a lot fatter.

/... more at site (Business): http://www.guardian.co.uk/leaders/story/0,,2243277,00.html

(DU Thread: http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=102x3146857 )

...from "wary" to "concerned." I expect to upgrade that to "very concerned" sometime next week. Hopefully, "ACK! We're all freakin' doomed!!" can be avoided. Hopefully.