The saga of the monoline credit insurers (MBIA, Ambac, FGIC, etc) continues to get more interesting and move faster. What happens with these companies has an enormous impact on the credit markets, from mortgage backed securities to municipal bonds. This week for the first time we've had some extensive failures in municipal bond auctions leaving local governments paying interest rates as high as 20% or having to shut down services.
During the congressional hearings on Wednesday, Eliot Spizer basically gave the monolines 3-5 business days to work with banks to figure out a private bailout out or face action by regulators. The action would almost certainly involve splitting the companies in two, with one side insuring municipal bonds (the good side), and the other holding everything else (the bad side). The bad side would pretty much immediately be downgraded to dirt and implode leaving anybody they insured out of luck. The governments primary concern here is saving the municipal bond market which is vital to our nation. Unbelievably, this might be one of the few times lately our government is actually putting the interests of "main street" before "wall street"
Then on Thursday a ratings agency, Moody's downgraded one of the big three bond insurers FGIC. FGIC's response to this was to ASK to be split up in order to save the good half of their business. Meanwhile investment banks have promised "instant litigation" in an attempt to split up the bond insurers. Why? That should be pretty obvious. In a split of the bond insurers they don't get any bailout and will have to write down some pretty extensive additional losses to their holdings. They want to force any attempt to save the municipal side of the business to bail them out as well by keeping them tied together. Some estimates for their additional losses they could realize to this are around $200B.
Over the next coming weeks this is going to echo in some real legal and legislative fireworks, as the interests of the investment banks are pitted against the interests of the states and local governments.
See also:
What are the Monolines and why is everybody trying to bail them out?
Oh boy, Credit Crunch round #4
Munis, monolines and Buffett's offer you "can't" refuse
Spitzer is on the war path...
Update #1:
It's now being reported by the Wall Street Journal that Ambac is is talks to split apart.
Ambac in Talks to Split Itself Up
Updated #2:
Bloomberg:Bond Insurer Split May Trigger Lawsuits, Analysts Say
``Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity,'' analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is ``likely to lead to significant legal challenges holding up the resolution of the monoline issues for years.''
Unfortunately the municipal bond market needs a resolution of this issue now, or there is going to be a lot more pain for local governments.
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In the middle of chaos lies opportunity. I am greatly enjoying your series, Matt.
The investment banks and large Wall Street firms are smitten with the failed auctions. Why? Because these are the same folks that underwrote the municipal debt. They now have a very effective pitch to school districts and toll road revenue bond issuers: Why pay 12% on a 4% original coupon when you can call these bonds and re-float another issue?
The hedge funds are already starting to nibble at these bonds, hoping they will be called. Could be in the final anaylsis the monoline debacle downgraded AAA bonds to A, produced a round robin of calls and generated new issues.
All to the delight of folks who get paid in fees. Will Buffet have the chance to step in?