This may be the Henry Ford moment where somebody forced the banks to 'fess up to their mess and the banks shut down for 6 months. I thought we'd see this after the elections but looks like Spitzer is taking the lead again.
While I understand the objective (keep the muni side of the house writing), and I understand the State's interesting in this, I don't understand how this happens. How is the "bad bank" capitalized, because it has to be to some degree? At what level? Then the minute this gets spun off it gets severly downgraded?
If I were a counterparty to this, I'd be calling in a stable of lawyers. What this would effectively be doing is waving the middle finger at all the counterparty contracts that didn't relate to the muni side. How is that possible?
I see how it makes great sense for shareholdes, CR, enabling the good side to write more business; nice insight.
I do not see how it makes sense for folks who bought credit protection on MBSs and CDOs. I presume they relied upon the reputation of a proven bond insurer that had been in business for decades, weathering many storms.
Why is Lerach behind bars, when we need him front and center to mess this up and get this house of cards to tumble? We need a jailbreak!
Conceptually, it seems to me it shouldn't be that hard to divide up the proceeds from the muni premiums and the bogus CDO premiums and allocate the rightful share to each. You could argue about the process, but the basic concept seems sound.
Of course the CDO premiums will be woefully inadequate to pay the claims, but there is no obvious reason why the munis should have all their premiums go to pay for the sins of the CDO players. And there won't be any sympathy for the CDO players because virtually everyone was complicit and played a part in creating the disaster.
This action has to be illegal. An insolvent instutition cannot makes itself solvent by "signing away" it's losses to a new entity. Contracts were signed in good faith. The pros did their DUE DILLIGENCE. This is why corporate bankruptcy exists. Liquidation of assets is part of the process. Another shmorgasborg for the attorneys.
Yes, albrt but a business uses profitable parts to fund other initiatives that may or may not turn out well all the time. This seems to be a question of mis-pricing risk. Back when those contracts were written risk was modeled to be one thing. Now the risk on these contracts is much greater and it is known that the risk is greater and was mis-priced on the original contracts.
So you just can't split it apart on the original assumptions without legal issues about what you know. If I were a counterparty here, and they tried to do this I'd be first in line to sue trying to get whatever I could out of them. They should be paying for that mis-pricing from any other profits they have, even if it's from the muni side.
If the CDO side is left undercapitalized and unable to meet its obligations when due, the transaction would raise a bunch of legal issues, such as fraudulent transfer concerns. You can't legally keep all the good stuff and leave creditors of the bad side (beneficiaries of the CDO insurance) holding the bag. Even if the CDO types are evil and unsympathetic.
Unless, of course, the regulators decide to make it happen.
There is only one way to unscramble a scrambled egg... that is to cut the scrambled egg into little pieces and feed it back to a chicken to digest and then lay a fresh egg.
What doesn't get digested gets 'passed' by the chicken in a different form - good fertilizer too.
Sounds a lot like bankruptcy to me. I think in the end that will be how this egg gets unscrambled too... those with claims to CDO coverage will not let go without one helluva a fight and it will drag all affected parties through the bowels of bankruptcy.
Given the trillions in credit default swaps, could it be that every bit of the real debt is hedged 6 ways from Sunday and the insurers are just one of the 6... Gotta be at least 5 other gamblers out there.
Wall Street is no better than Vegas, except that nobody has a complete grasp of the rules, the odds are unknown and there is literally NO limit to the betting...
Wall Street is no better than Vegas, except that nobody has a complete grasp of the rules, the odds are unknown and there is literally NO limit to the betting...
Worse actually... at least in Vegas there are large breasted girls walking around showing cleavage & bringing you drinks while you lose your money... hey wait, maybe that was CNBC I was thinking of instead.
Conceptually, it seems to me it shouldn't be that hard to divide up the proceeds from the healthy patients and the bogus cancer patients and allocate the rightful share to each. You could argue about the process, but the basic concept seems sound.
As was pointed out in the last thread, perhaps this isn't a precident that should be set. If there is an underlying legal structure that separates the muni and CDO risk pools, then everything is different. But I haven't seen that mentioned.
suggest those of you interested in this read up on "liability based restructuring."
there is a lot of precedent for this in the banking area.
there is not much in the insurance area.
in addition i am still unclear whether the cds contracts on which these monolines sold protection are legally insurance policies or simple securities making their customers simple unsecured creditors and not policyholders.
Where's Harvey Pitt on this? I vaguely remember he was representing hedge funds who were claiming that they were getting burned by manipulators of the CDOs that the hedge funds were protecting by writing CDS. A feast for lawyers.
My guess is that if this stuff gets too messy, Congress will make the splits legal. If municipalities and states can't borrow money on reasonable terms because of the monolines, something will get done quick to restore order.
Regardless of the outcome -- downgrade vs. quick "split" fix vs. massive legal quagmire -- I don't see any way this is going to be good for the markets.
what really depresses me is that the state govt's are doing whatever they can to preserve their access tocapital markets but they'll fail too. now the symptom is the lack of insurance on the bonds, but the very fact of "insurance" is the moral hazard in the system because it encourages irresponsible borrowing. When the state govt's has destroyed the banks, who will provide the capital for their bonds? what funds will have the capital to buy them? and how can the state governments point to higher revenues when their own finances are screwed because real estate transaction taxes and property tax incomes are devastated!
Not sure if it's just me but I can't bring up David Merkel's The Aleph Blog.
So I will paraphrase his money quote:
"Anyone else trying this would be committing fraudulent conveyance, but I guess when you have state government behind you it's called public policy."
Basically he is saying NYS cannot act in such manner so as to throw one set of policyholders under the bus.
He expects instant litigation on the part of the IB's.
If he is right and NYS cannot successfully counter-argue I would expect that enough capital would have to be deposited in the structured-finance newco to satisfy IBs.
And I am wondering if the muni newco might start out with no capital e.g. the newco would be capitalized completely with fresh funds while the s-f newco would be in "runoff" mode.
My other thought is that, given Dinallo's admission that he asked Buffet to appraise a deal to buy time over MLK weekend, Dinallo may have put this forward to buy more time.
Game theory will provide the 1st plan of action, legal pecedent will provide the 2nd, the spanish concept of "buttfucking*" will be the final plan of action.
*this refers to the willingness of one party, even in a position of strength, allows a less than optimum outcome from his position because the binary outcome is worse for both parties in the long run.
Correct me if I'm wrong, but wasn't it established that the muni premium is paid in full up front, whereas the non-muni premiums are paid over the life of the policy? If that's the case, there's no way they can leave the muni side with no capital is there?
NSA is onto something, but I'm thinking of property settlements in divorce. I'll split off my valuable stuff (house, boat, BMW, cottage, jewelry, etc) from my lousy stuff (credit card debt, student loans, what I owe the landscapers and cabana boys) and my ex gets to choose from the latter category.
The relative safety of muni bonds is based on the relatively low rates of default on their bonds in the last quarter of a century. But there are several reasons to worry that default rates by state and local governments may sharply increase during the coming US recession.
First of all, the previous two US recessions in 1990-91 and 2001 were relatively shallow lasting only 8 months - and did not affect as severely the finances of municipalities...
Second, state and local governments rely heavily on three sources of revenues: fees paid by real estate developers; property taxes; and sales taxes...
Third, an economy-wide recession will have much more severe effects on the fiscal conditions of state and local governments in regions where the housing boom and the home prices bubble were particularly large...
Fourth, many state and local governments will have very large fiscal financing needs in the next couple of years.
And I am wondering if the muni newco might start out with no capital e.g. the newco would be capitalized completely with fresh funds while the s-f newco would be in "runoff" mode.
That's what Buffet proposed.
And the payout on CDO insurance is pay as you go - not marked to market payout.
Most of the business splits I recall happened to try to juice the stock of the original entity by unloading the part(s) considered underpeforming. None of these, I recall worked particularly well.
With these insurers, that ship has sailed. There's no way to get the stink (liability, crookedness) off the supposedly good side of the business.
Buffet's plan makes more sense, and seems at least somewhat likely to be able to restore some stability to the govt markets.
I hereby announce that I will be separating myself into two persons! The first, "Peripheral", will take responsibility for the student loans, credit cards, and rent payments. The second, "Visionary", will take responsibility for the salary, clothes, computer, and retirement fund.
Now I just need to put together the paperwork to make it all happen. If companies can do it, why can't individuals?
I think this link will bring up a copy of the text of the Aleph blog post I cited.
TJ: Admittedly I am talking out of my ass here. I'm just wondering if it's possible to split the b-i's into two newco without both newco having sufficient capital if the fraudulent conveyance objection has any traction.
I don't know insurance law so I don't know if fradulent conveyance applies to policyholders as opposed to creditors or whether it can extend to any party under contract.
What does surprise me is that Dinallo did not address capitalization of the s-f newco on Friday.
To answer your question I should rephrase: the muni newco would be capitalized out of the gate with fresh capital of such amount to satisfy municipal policyholders.
Or, Dinallo and Spitzer are playing a Big Game of Poker with the aim of getting b-i's to voluntarily split.
I agree that a split would be illegal. The existing shareholders would need to be wiped. This would need to function as a defacto BK. That way new capital could be raised for the solvent side of the split with a clean slate and no entanglements from the IBs. The new capital would fund defaults on the muni side while the esisting capital would fund the IB side followed by a quick default.
"ANZ spokesman Paul Edwards confirmed the insurer as New York-based ACA, which had its rating sliced 12 levels to CCC by Standard & Poor's in December, casting doubt on more than $75 billion of debt the company guarantees, including $69 billion of securities such as collateralized debt obligations."
Will "bad bank" that spun out from Ambac get better than ACA? I don't think so...
Of course, the whole split concept could be just another delaying tactic during which various bagholders unload what they can or otherwise mitigate their upcoming losses.
Previous post apparently eaten by haloscan - sorry if this turns out to be a duplicate:
It is important to recognize that we are not talking about a solvent entity here, so we are not talking about retribution for whatever the insurer may have done. As a practical matter, it doesnt matter what type of coverage people thought they were getting because the company that made the promises no longer exists. We are only talking about how to divide up the assets, and whether it is possible to increase the total assets by creating a solvent insurance company out of part of the wreckage.
It is like bankruptcy, except instead of going to bankruptcy court the actual insurance companies are controlled by state regulators. It is not uncommon for an insurance company to accept control by state regulators even if there has been no formal determination of insolvency. The state regulators primarily care about policy holders. Creditors and stockholders get what is left over (generally nothing) after all policy claims have been satisfied (which can take many years).
But the regulators dont necessarily have to treat all policy holders equally, and in fact they cant given the different types of policies that charge different premiums and are designed to do different things.
In this case, you have municipalities that mostly played by the rules, and mostly paid premiums that were reasonable under the circumstances. I think most people (including the state regulators) would agree they should get what they paid for. That doesn't mean the muni side won't become insolvent, but the runoff should at least be somewhat orderly.
On the other hand, you have the Ronco Bond-O-Matic industry in which all the players were either as crooked or as foolish as they could possibly be. They paid premiums that were completely inadequate to cover the risks involved. I think most people, (including the state regulators) would agree they should also get what they paid for. If investors suffer additional losses after the insurance money is gone they should look to the people who created these things and misrepresented the risks involved.
By the way, in case the implication above wasn't clear enough, the stockholders in these companies have already been wiped out. Some of them just dont know it yet.
I think CR's opinion that the "good side" of Ambac can go back to writing a stream of new muni biz is wildly speculative. There will be a legal cloud over the "good side" for some time, and their claim of in-house credit analysis and "zero loss" standard is forever shot. The good side will be downgraded below AAA soon, and as the recession deepens the good side will have its own flow of muni defaults to deal with. Most issuers aren't so desperate for insurance that they will just start throwing money at Ambac again.
The munis were never the major problem. Yes, the munis can be saved. But that does nothing for the real problem...the mortgage securities insurance.
If anything, spitting into two businesses will pull the last mask off the charade. Party over. Time for everyone to go home, lick their wounds, and nurse the hangover.
albrt: On the other hand, you have the Ronco Bond-O-Matic industry in which all the players were either as crooked or as foolish as they could possibly be.
But let me say that we would not be in the quandary we are in now if Ronco really was in the bond industry. At least his products, whatever they are, work as intended. I'll take a Ronco Bond-O-Matic over a CDS any day of the week. Plus, you get a free baldness cover spray with it! But wait, there's more!
While we are focussing on the death throes of the monolines,I wonder what will be coming out of left field in the next few days or weeks.ABCP was a surprise last summer,and it feels like it is time for our next surprise guest.
Correct me if I'm wrong, but wasn't it established that the muni premium is paid in full up front, whereas the non-muni premiums are paid over the life of the policy? If that's the case, there's no way they can leave the muni side with no capital is there?"
The prepaid muni premium is in the unearned premium reserve -- about $1.4 billion for FGIC and $3 billion for Ambac.
This isn't capital but a liability for the combined company.
"j writes:
And I am wondering if the muni newco might start out with no capital e.g. the newco would be capitalized completely with fresh funds while the s-f newco would be in "runoff" mode.
That's what Buffet proposed."
The Buffett proposal was to take the unearned premium reserve plus capital equal to 1/2 or 1.5 x the unearned premium reserve. To that, he would add additional capital. This would put the new company at true AAA levels.
Any of the new proposals would have to be better then the Buffett proposal. Buffett would have left most of the capital in the old/bad entity and put the new entity clearly up to AAA levels. The holding companies would have gotten no benefit (hence the pitch to the regulators and public instead of the companies).
It will be interesting to see who benefits more from the new proposals -- management, stockholders, or non muni insureds. If all the benefits go to the bad/old company insureds/policyholders, then it makes sense. If not (which I strongly suspect), then it will be interesting to see who is trying to grab what.
Frankly, I don't think Buffett cares very much one way or another. He made a bid to clear the decks on the whole mess. If other people want to throw a lot of capital into the muni business, then he has other opportunities to allocate capital. This is a great time for deals if you have plenty of cash. If they try to capitalize the new muni companies thinly, then his company which is a solid AAA will get first shot at new business.
The word "split" seems to be causing some confusion. The end result is to get the muni side on the market working again. Buffett appears to be willing and able to do this. The response to a systematic crisis doesn't have to be legal, it just has to fix the immediate problem. Shareholders and IB's be damned. That mess will be addressed after the muni's are fixed.
(that's somebody's moniker, not a self-revelation )
Here's a post from Yves Smith over at Naked Capitalism all about credit default swaps.
That's nice. I know what a credit default swap is. However, I had a very specific question, and your link doesn't answer it. Are credit default swaps, legally an insurnce policy. I'm not asking what they are in practice; I'm asking how they get treated in a technical sense.
There are a lot of things about a CDS that work like insurance. There are also a lot of things about them that don't.
Your question is your answer, Grasshopper. Basically, if it is regulated then it is insurance. If it is unregulated it is CDS. We appear to be talking about insurance with AMBAC.
...That the banks which would be screwed by having their CDO's stuck with the insurance from the "Bad Bank," instead of tying it up in court for God knows how long....
The word NOW is that these banks are being offered equity in the "Good Bank" to make them "whole."
Spitzer and FGIC & ABK tried to end-run the banks, got threatened with "Instant Litigation," and will now end-up giving over to these same banks the very pieces that Buffett would have paid a significant amount of Jing for just a few days ago.
if you think this is so simple or obvious or for that matter without massive import...
if a monoline insurer wrote an out of the money cash settled knock-in put on the spx to make a little money, would that be insurance, and the counterparty an insured/policyholder?
get it?
no one anticipated this when they allowed the monolines to "insure" this stuff...
you tell me what the difference is between an insurance policy and an investment with an embedded put...
classically insurance is reserved and funded by aggregate variance reduction, meaning a life insurer holds a book of so many lives that the probability of having a significant deviation from expected profit (premium minus loss) is nil...thus the risk is retained but minimized by the law of large numbers.
thats a bit damn different from just contracting that "you pay us $x every quarter unless soft default credit event X occurs then we pay you $y"
or is it?
are all contingencies insurance?
its not a joke.
and incidentally im a securities and tax lawyer and a quant and i dont have an answer. i dont practice in insurance recovery but i have colleagues who do and id be amazed if theres a cogent answer.
and "if the company is regulated then its insurance" isn't. this isn't a case of the simpler the better.
While I would be the last one to claim that something as mundane as bankruptcy law would be enough to stop Elliot Spitzer from over-reaching, I doubt a simple grab of the assets away from the structured finance policy holders is what is contemplated.
I think the model that may be invoked here is something along the lines of the asbestos trusts that used the equity of the defendent firms to generate capital to fund the trusts. In this case, a muni newco is formed, perhaps with some new outside funds, but with the balance of the equity being reserved for the existing structured finance policy holders. At some point down the road, the equity in muni newco is monetized and those funds are used to help pay the claims of the structured finance policy holders.
At the end of the day, it is unlikely to be enough to satisfy all the claims of the structured finance policies, but it is probably the best hope of generating capital with which to pay those claims - let's face it there are no sources of capital that will step up and fund the structured finance side of the business.
The muni side of the business is viable if it can shake free of the non-muni toxicity. If that can be achieved, then the franchise value of that business can be monetized down the road. If things stay on the current course, there will be no value left in the muni side of the house when the whole thing goes into run off. Of course the current shareholders would be wiped out in a plan like this, but the management teams will probably go along with it as long as they get some options and a job in newco. Better that than a slow an ugly death in run off.
It appears that the structured finance liabilities which were written in the "transformer" entities are guaranteed by the parent orgs (according to the WSJ) so it seems unlikely that there is any effective ringfencing that can be done here without some kind of consent of the policy holders.
Spitzer needs something to happen quickly, they will cut some kind of deal that gives the CDO owners a reason not to sue.
and incidentally im a securities and tax lawyer and a quant and i dont have an answer. i dont practice in insurance recovery but i have colleagues who do and id be amazed if theres a cogent answer.
fred - I commented on a different thread yesterday or the day before that I wouldn't be surprised if this goes all the way to the supremes. That is unless there isn't a case by then 'cause all the litigants are 'dead'.
Seriously - I see no way this ends cleanly until all pockets are empty.
the easiest way to avoid all the lawsuits would be to downgrade the whole companies, let them go BK, and then call in Buffett to pickup the muni bonds at firesale prices. forget the CDO's.
Remember that you all heard it here first, this is desperation, posturing, and the last ditch effort to salvage the existing equity.
Take a step back and look at the recent unfolding of events, will not raise new capital, Fitch downgrade, scoffs at the Buffet proposal, emphasizes the claims paying ability of the existing entity, statement from the regulators in regard to a potential split if capital is not raised through a market-based solution, all of a sudden they are potentially splitting in two on their own.
Bullshit, this is posturing, nothing more, nothing less.
I also find it interesting that MBIA had made various previous statements surrounding their exceeding the ratings agency rating requirements for AAA, noticibly absent from the congressional testimony were like statements.
Things are changing very rapidy, I would expect this to continue next week as well.
I have stated what the solution should be at any cost, problem is that the current participants ain't gonna like it.
the easiest way to avoid all the lawsuits would be to downgrade the whole companies, let them go BK, and then call in Buffett to pickup the muni bonds at firesale prices. forget the CDO's.
Even that won't be 'fast enough' to save anything really... a pre-packaged BK will still take many months to go in and out of BK... even if everyone agrees.
I think the model that may be invoked here is something along the lines of the asbestos trusts that used the equity of the defendent firms to generate capital to fund the trusts.
How long did the asbestos settlements take for everyone to see the light, capitulate & sign on? It was years wasn't it?
Sorry, I didn't intend to be condescending. I was trying to get into the spirit of the Onion article.
I have not researched any details concerning these particular companies, but regulated insurance companies generally can't just say they are writing something other than a true insurance policy in order to avoid regulatory requirements.
They also can't take their reserve funds and invest in speculative, unregulated contracts like most credit default swaps. Their reserves have to be kept in very highly rated bonds. Given the problems with the rating agencies some of those bonds may not be so great after all, but they probably aren't credit default swaps.
The holding companies or other non-regulated affiliates may have "invested" in CDS, but that is not who the regulators are talking about splitting.
Fred:
I will stick with my answer, without posting my credentials to mislead people into thinking this is legal advice. I think it is a pretty good rule of thumb.
It is one thing to analogize an unregulated investment contract to "insurance." It is quite another to claim that it really is the same thing as insurance. In fact, I would say that a good percentage of what has happened in the past five years is that the high-speed Wall Street folks apparently forgot what an analogy is.
A purportedly inverse-correlated investment contract is a "hedge." It is not "insurance" unless it has the safety features associated with boring old insurance companies, including a known place of business, strict reserve requirements and a legitimate regulator.
Kirk asks for a damage report from Enterprise. Spock reports that "by the book, hours would seem like days" and that transporters will be available in two days.
I just don't see how screw the equity is the correct solution. Contrary to the postings here, Dinallo and Spitzer have made it clear that the issue is not about solvency, only the need to maintain a AAA rating for the sake of the muni market. How that translates into wipe out the equity and give it to the banks is beyond me. Did Ambac ever agree it would maintain a AAA rating? I doubt it. It seems to me you could capitalize both entities and each would remain solvent. Admittedly, the CDO ratings would suffer, but if this Company was purely in the CDO business that would have happened long ago - the muni side was propping up the CDO ratings.
Why should the banks get anything?
Why AMBAC (and the other monolines) as a regulated insurance company was operating the unregulated derivative contracts called Credit Default Swaps to "protect" (I didn't say insure) the subprime CDO derivatives? They got caught, didn't they?
That is a very good point. There are a lot of cats to herd here.
On the other hand, the tort bar had every incentive to spend time trolling for every possible asbestos claimant out there (and the rate of medical inflation may have also been an incentive not to settle quickly - if you were a lawyer). I think there is a greater sense of urgency here on the banks' part. The jig is up on the AAA ratings in the current monoline configuration. I think (I'm speculating) the banks are better off with a AAA muni entity in which they can own most of the equity rather than hoping for the best from something that is in runoff.
I don't know much about the latitude of insurance regulators, but I'm guessing that body count in the auction rate note market will push Spitzer toward a deal that doesn't face months of litigation - so there has to be something in this for the structured finance policy holders.
I think that the hole point has been lost in the argument dinallo and sptizer want to save the minis therefore they are trying to save the aaa on the munis, if the companies are split be split to be save are you going to put your money in munis insured by new old or any of the 2 new?
Did Ambac ever agree it would maintain a AAA rating? I doubt it.
I don't have a link handy but I think the answer is 'yes they did'.
The assets they insure only carry AAA ratings as long as the insurer that insures them maintains their AAA... if the insurer falls so do the insured assets... and the funds holding those assets (pensions and other insurance funds) are required to hold ONLY high rated funds... so they dump those assets en mass if the 'chain reaction down grade' occurs and that starts with the monolines.
Why should equity get hosed is a different matter - I personally don't see how they do get hosed until some kind of due process gets completed... either bankruptcy or regulatory event. Either way 'due process' takes a bunch of time... for the first finding and then all the subsequent appeals.
Feb. 18 (Bloomberg) -- The risk of Asia-Pacific companies and governments defaulting on their debt rose on concern that a proposal to split U.S. bond insurers may spark further credit losses, credit-default swaps show.
as a lawyer i wouldnt dream of giving legal advice without careful analysis and a big retainer. as a quant i can give mathematical advice, because it's wrong or it's not.
here it be:
mathematically, insurance and derivatives are indistinguishable. both are methods of contracting for payments in whole or in part depending on contingencies. hence the concept of "life contingencies" (derivatives) or "contingent claims"
i dont argue for a minute that a verbal definition can be attempted.
but that doesnt mean it has mathematical validity.
if your position (this is a debate, not an argument) is that by allowing a monoline to sell protection on a cds, then that is insurance by definition, then watch:
(nothing up my sleeve):
assume for simplicity (im not being coy, the details dont change the thrust) that a credit event in a cds is the same as an actual default such that holding the physical security (bond or bond equivalent) would suffer, then riddle me this:
monoline X sells protection on a AAA tranche of something, say a CDO.
monoline Y doesn't touch the stuff. pure as the driven snow. they just insure (or "insure") munis.
of course monoline Y has to invest its reserves, so it invests its reserves in a mix of corporates and munis.
i submit that monoline Y, by investing in a AAA corporate bond, has just taken on the mathematically identical risk of monoline X.
so does that mean every time you buy a bond from someone you've just insured them?
this isn't silliness, and indeed if there were an identity of soft default and physical default then the two positions would have to be identical (assuming identical names/credits, or that AAA risk is fungible) or there'd be an arbitrage (cf. negative basis plays).
my point is that to say that its insurance because its risky and thus its not an investment because they have to hold their reserves in super safe investments isnt going to work because selling protection on a AAA cds should be LESS risky than almost all the bonds the monoline is holding as reserves, no?
to argue with that is to take a position that it was always known or knowable that the AAA on a cds was bs...
in which case why would the regulators allow it to begin with?
much of law as you well know involves distinctions without a difference
but this time its going to be a hugely visible mess.
I came across three items that make a distinction between financial guaranty insurance and credit default swaps. My best guess is that financial guaranty insurance policies
(1) need to be issued by an entity defined as an insurance business per a given state's insurance regulations, and
(2) provide for performance in the event that a financial debtor fails to pay despite its obligation due to default or insolvency.
Excerpt from MBIA response to Ackman's letter to regulatory authorities:
"...All financial institutions who take and manage credit risk in buy and hold positions are required to make estimates of uncollectibility or credit impairment. MBIA has a rigorous process for determining the amount of credit losses in our portfolio of financial guaranty policies and our CDS contracts (it must be remembered that our CDS have the character of financial guaranty insurance policies, not tradable CDS as transacted by most market participants). The process of recognizing loss on our contracts for statutory reporting is governed by SSAP 5, which is consistent with FAS5 (Accounting for Contingencies). Our reserves are based on reasonable estimates of probable losses, in accordance with the guidance. There is no provision in GAAP or statutory reporting for reserving based on worst case hypothetical losses. In no way does the fact of internal estimates permit a bond insurer to “determine statutory capital.”
[Note that MBIA did not say it was a financial guaranty policy, only that it had "the character" of one.]
Except from NYS Insurance Office of General Counsel Opinion regarding financial guarantee insurance:
N.Y. Ins. Law § 6901(a) (McKinney 2000) states in relevant part:
(a) (1) "Financial guaranty insurance" means a surety bond, insurance policy or, when issued by an insurer or any person doing an insurance business <b> as defined in paragraph one of subsection (b) of section one thousand one hundred one of this chapter,</b> an indemnity contract, and any guaranty similar to the foregoing types, under which loss is payable, upon proof of occurrence of financial loss, to an insured claimant, obligee or indemnitee as a result of any of the following events:
(A) failure of any obligor on or issuer of any debt instrument or other monetary obligation (including equity securities guarantied under a surety bond, insurance policy or indemnity contract) to pay when due to be paid by the obligor or scheduled at the time insured to be received by the holder of the obligation, principal, interest, premium, dividend or purchase price of or on, or other amounts due or payable with respect to, such instrument or obligation, when such failure is the result of a financial default or insolvency or, provided that such payment source is investment grade, any other failure to make payment, regardless of whether such obligation is incurred directly or as guarantor by or on behalf of another obligor that has also defaulted[.] (emphasis added)
Thus, the principal distinction between financial guaranty insurance and surety insurance generally rests on whether the primary obligation guaranteed is a financial debt (such as payment of a deposit) or is some other type of performance (e.g., delivery of goods), unless it comes within one of the other provisions contained in N.Y. Ins. Law § 1113(a)(16) (McKinney 2000), such as subparagraph (D) or (E). Hence, the contract that was denominated a "surety deposit bond" in the firm’s inquiry is financial guaranty insurance under the New York Insurance Law.
blowncue | 02.18.08 - 12:07 am | # - I have no idea what all that means but I think you just provided evidence for the case why this issue isn't going to settle cleanly or settle fast...
If we accept the idea that a pre-packaged BK acceptable to all parties is the only way this thing can be resolved quickly, the idea of the IBs getting all the equity in the muni side in return for allowing the split makes some sense. Among the parties involved -- government, IBs and shareholders -- I'd say the shareholders would be the weakest and easiest to jettison in a BK. Heck, don't corporate BKs usually do that anyway?
"There seems to be growing unanimity of opinion among investment and risk professionals that many structured assets and associated fair value accounting rules are Acts of Satan"
Feb. 18 (Bloomberg) -- Citigroup Inc., the largest U.S. bank, plans to hire ``hundreds'' of employees in Japan this year to sell investment products to affluent customers, even as it cuts jobs globally after a record loss in the latest quarter.
Psssst. Hey buddy: you all set on CDS? 'Cause this sh*t here is all insured and everything. Go on, try some.
Fred, I believe you've made my point for me. If you are a high-speed, modern Wall Street type and all you care about is modeling the risk characteristics of the transaction, then buying a bond can be considered similar to insuring a bond to the extent you are in the position of taking the loss on default. But you are insuring yourself as the bond holder, you are not insuring the issuer or other bond holders.
As a practical matter, actual insurers buy actual bonds with their reserves. They may suffer losses, but the investment managers don't promise to pay anybody else's losses, so they pretty much always have some non-zero percentage of their capital left to pay claims.
By contrast, when the insurance companies insure bonds they promise to make payments far greater than their capital on the assumption that they can predict the likely actual losses. It is a fairly extreme form of leverage. It is highly regulated because sensible people in the past thought it was a bad idea to take highly leveraged bets and call them "insurance" unless there was some way to verify that the insurers were acting reasonably and not putting the reserves into pork bellies or paying the reserves to themselves as bonuses.
I think Blowncue's excellent post is pretty consistent with what I am saying.
"tj & the bear writes:
If we accept the idea that a pre-packaged BK acceptable to all parties is the only way this thing can be resolved quickly, the idea of the IBs getting all the equity in the muni side in return for allowing the split makes some sense. Among the parties involved -- government, IBs and shareholders -- I'd say the shareholders would be the weakest and easiest to jettison in a BK. Heck, don't corporate BKs usually do that anyway?"
tj.....
We aren't at bk levels yet -- we are still technically at AAA.
However when the fate of the global financial system depends on $15 billion of capital in bizarre, archaic statutory insurance entities, we are beyond the twilight zone.
Thats what happens when you mix fas 5 and fas 133.
"Feb. 18 (Bloomberg) -- Citigroup Inc., the largest U.S. bank, plans to hire ``hundreds'' of employees in Japan this year to sell investment products to affluent customers, even as it cuts jobs globally after a record loss in the latest quarter."
No, this isn't the American stuff. It is from China. Best stuff in the world. Disregard the fine print. No that isn't English. Really, trust me, that may look like English, but it is Chinese. I wouldn't try to sell you America CDOs. This is the good stuff. It is Chinese...
I was preceding on the assumption that the only way you could legally split the "monolines" would be through the regulators forcing them into receivership. Just thinking aloud here.
Dryfly, I think there will be lots of litigation, but the regulated insurance entities will mostly be involved on a simple level - the ordinary questions such as "was the claim covered?" plus the less ordinary question of "is there any money?"
Once the New York commissioner tells them how to split up the companies, nobody is going to get very far suing them for doing what the commissioner said. They will just have to settle for suing each other (and the rating agencies).
Assuming that the CDS insureds get equity in the new muni insurance entity, if their equity stake will be large enough to offset the losses on CDSs, the current equity holders must be diluted to a very large degree; in essence wiping out the vast majority of their equity value. This is tantamount to the insureds buying the insurer, which, short term, has no value. Maybe once the markets stabilize, the muni segment become valuable enough to offset some of the CDS losses, but until then, this is just a salve for the muni market and does nothing to help the investment and commercial banks that depend on the monolines' AAA rating.
Sorry, Keep It Simple asked whether a credit default swap was, legally speaking, an insurance policy. Which, unfortunately, is not a simple question. Short answer, no, unless an insurance company wrote it as such.
The first citation was to show that an insurance company drew a distinction between credit default swaps and financial guaranty insurance.
The second and third citations attempted to give a general and legal definition, respectively (at least in New York State) of financial guaranty insurance.
It was a technical question that I would say is only relevant insofar as who "adjudicates" disputes between parties to a cds e.g. NYS Insurance Commission vs. ? if its Joe Blow Hedge Fund who sold protection.
The new york state insurance regulator should just just shut down the monolines and put their assets and business up for auction sale so qualified buyers such as Buffett came come in and run this muni business properly.
He warned these idiots about how dangerous these overleveraged derivatives were.
Although I like Buffett immensely, let's not forget he was buying FL real estate brokerages in 2005 and he had been adding to his Wells Fargo stock at a very questionable time. His words are not always gospel.
"I have stated what the solution should be at any cost, problem is that the current participants ain't gonna like it.
risk capital | 02.17.08 - 11:27 pm"
As usual there is a lot of misunderstanding here...
dryfly: "Did Ambac ever agree it would maintain a AAA rating? I doubt it." I don't have a link handy but I think the answer is 'yes they did'. "
Monolines don't guarantee ratings. All they guarantee are timely payments of interest and principal upon default. In some rare cases (like SCA), they may be penalized or required to post collateral but generally ratings have nothing to do with the business.
Keep It Simple, I'm Stupid: "Do credit default swaps legally count as insurance?"
Well, seems like simple question but I don't know the answer. I've read through a lot of Ambac and rating agency reports (I'm a shareholder) and it's never clear to me what is legally considered as 'insurance'.
What I can say is that the pay-as-you-go CDS-type contract that monolines use for structured products are constructed similar to a muni bond insurance contract and is considered a 'financial guaranty' product. But I don't know what a court of law considers as 'insurance'.
I suspect the monoline CDS-type contracts are insurance since I havent heard of anyone other than a monoline write a financial guaranty product. If they werent insurance products, everyone else would be writing the same CDS-type contracts but others (like hedge funds, banks, speculators, etc) seem to write the plain vanilla CDS contracts. Since insurance is heavily regulated, we also would have ended up with a lot more unregulated companies writing the CDS-type pay-as-you-go contracts but that never happened (all the unregulated hedge funds and others write the conventional CDS contract). So I think the monoline CDS contracts will likely be considered as insurance.
Navin R. Johnson: [bleakly] I've already given away eight pencils, two hoola dolls, and an ashtray, and I've only taken in fifteen dollars.
Frosty: Navin, you have taken in fifteen dollars and given away fifty cents worth of crap, which gives us a net profit of fourteen dollars and fifty cents.
samuel: ``The new york state insurance regulator should just just shut down the monolines and put their assets and business up for auction sale so qualified buyers such as Buffett came come in and run this muni business properly. `
In case it escaped your mind, there is something called property rights in USA. Itll be awefully tough for the government to shut down anyone when they have capital above the statutory requirements. Doesnt matter what Spitzer and others think. The fact that his constituents don`t want to pay a higher fee to Berkshire Hathaway Assurance, or Assured Guaranty, or others, willing to insure muni bonds is his problem.
That's perfect ! I rate his journalism ( in my very rudimentary way I've tried to learn by living amongst the people - "Road to Wigan Pier - George Orwell" style in 3 countries. ) - I'll listen to those interviews AND get the book I think.
Interview with Eileen Barthe, a relief case worker, on the humiliation to the recipients of relief. Interview with Dorothy Bernstein, a waitress, on the shame in welfare. Interview with Virginia Durr on shame and the fact that people blamed themselves and not the system. Interview with Elsa Ponselle on shame and the lack of jobs. Interview with Anna Ramsey on shame, mortgage loans, and credit. Interview with Herman Schulmin who remembers shame and humiliation. Interview with Tom Yoder, the son of a suburban housewife, on food shortages and the shame in poverty. Interview with Larry van Dusen, a retired labor organizer, on the shame and depression in poverty and the rootlessness of his generation. Interview with Ben Isaacs and Ward James on shame in taking relief and prying case workers.
Reading those you can't help but note how attitudes have changed.
What's worse, I am a paralegal. Which really qualifies me for nothing. You might as well query the guy that changes your timing belt.
Nothing that I have ever written or will ever write should be construed as legal advice.
There is no subsitute for the lovely and talented members of the Office of General Counsel in the New York City office of the State of New York Insurance Department. The smart and sexy always ask them for an informal opinion.
I'm surprised we haven't heard from any biochemists yet. Since the yolk is largely lipids and the egg white is protein (albumin), I'd guess that there is a procedure of solvents and centrifuging that would separate the two, with out really being able to reassemble them. Hmmmm, and I'm guessing if the analogy holds, the solvent is lots of money and the centrifuge is lawyers and regulators,...so it's all good,...
"LaCrosse Financial Products, LLC (LaCrosse) was created in December 1999 to act as a counterparty for structured derivative products, primarily pooled credit default swaps. While MBIA does not have a direct ownership interest in LaCrosse, it is consolidated in the financial statements of the Company on the basis that substantially all risks and rewards are borne by MBIA. MBIA's guarantees of synthetic CDOs are typically executed through LaCrosse, which enters into a credit default swap with the counterparty. MBIA Insurance Corp., through a financial guarantee policy, then guarantees the obligations of LaCrosse under the credit default swap."
Is it insurance or is it a derivative? They do it in two steps. It starts out as a derivative which is then guaranteed through a policy issued by MBI insurance.
I don't think in the long run there's much difference in the holdings of the "good" bank or the "bad" bank. The bond insurers face a liability because some of the bonds won't be able to pay
then the "good" muni bonds are left uninsured. Which means the price of credit for municipalities goes up. Loss of tax revenue (because of the sub-prime mess, lack of consumer confidence, and poor investors of MBI losing their shirts) for municipalities further imperils their ratings - meaning the good banks won't be good for long.
State and municipal govt's will need to cut spending and raise taxes!! (See what Schwarzenegger is doing in CA). The federal govt. may have to step in and insure bonds - if so, the dollar goes down. What this all means to us? BUY COMODITIES!
Well, this is really uncharted territory for insurance regulation, and you can tell the regulators are making it up as you go. None of the regulators has a guidebook for this situation.
It will be interesting to see what MBI and ABK do when the market opens. I think up to half the stock price may be a bailout premium -- a hope that either IBs or the public would provide enough capital to keep them whole. That seems to be sliding away. So, there could be a big and fast drop.
Re: splitting the monolines, I was thinking back to college (almost 15 years ago now) and a class that I had where we discussed a hotel chain (Marriott, Hilton, one of the bigger chains) where the hotel split putting all the good assets into one company and all the garbage into another and issuing stock to the existing shareholders. Does anyone recall how this worked out and if there were specific laws put in place to prevent this sort of thing from happening again?
I've looked, but haven't had any luck looking for the specifics on that...
Assuming that what you are now seeing are moves of desperation in light of the recent regulator public statements and this potentially a last ditch effort to preserve equity through some market-based solution to split the companies voluntarily. In the end, in my opinion this fails. The crisis of confidence is in full force and the liklihood of restoring a frozen market with a split backed by banks, hedge funds, distressed debt investors, etc, in the interm-long run makes little sense and likely leads to the same result. In other words, you get a temporary reprieve if this is successful which I greatly doubt, but, work your way towards the same locked-up markets due to the lack of confidence which currently spreads well beyond the insurers.
That said then, the posturing that you are now seeing is likely due to the realization/private statements that downgrades are imminent, the ability to write new business has been compromised, and a regulator-based solution is likely.
If the regulators understand this, which I believe they do, then what you will ultimately see is a Buffet "or" equivalent solution where the credit quality of the endgame is not in question and confidence in the municipal aspect of the business is not in question and the market begins to function once again.
If this happens, then the stability being restored to the muni business provides time to allow for participants to replace floating rate debt with fixed lines of credit at fairly attractive rates. I think it interesting to see whether the auction rate market returns, this for two reasons; the whole concept of the potential for liquidity driven events due to borrowing short & lending long and also the current regulatory backdrop & investigations regarding bidrigging.
I agree with everything you wrote. Nobody can just rubber stamp the whole automatic AAA, "no loss underwriting" assumption about monolines again. This gives the ratings agency a "free pass" to go back to the drawing board and figure out what the right rating should be for each entity, and it won't automatically be AAA.
All bond issuers going forward will have to evaluate insurance for each issue on a case-by-case basis. The game has forever changed, to the detriment of the bond insurance industry.
Off topic, but very interesting comment. Tim Duy via Yves Smith at Naked Capitalism:
Indeed, all the housing market doom and gloomers are missing the big story how Bernanke is actually fueling a housing boom! Trouble is, the boom is in Hong Kong. From the Wall Street Journal:
because two weeks ago and half a world away, the U.S. Federal Reserve cut interest rates again, hoping to stimulate an economy dragged down by a housing sector in disarray. Since Hong Kong pegs its dollar to the U.S. currency, it followed the Fed's lead, knocking the city's base rate down twice in less than two weeks for a total of 1.25 percentage points.
The unintended result: home-loan rates so cheap that they are throwing more fuel on an already scalding property market.
A typical mortgage here -- which is pegged to the prime rate which, in turn, is tied to the base rate -- now carries interest of about 3.1%. But compared with Hong Kong's inflation rate of about 3.8%, which is hovering at a more-than-nine-year high, that looks especially inviting, creating a so-called negative real interest rate.
Let me say up front, I know very little about this whole mess, and understand less..........
But years ago I heard a question asked of Buffett once along the lines of aren't the derivatives (CDSs) just a form of insurance. His answer "NO". He didn't explain and that was the end of the discussion.
In 2002 annual report Buffett called these derivatives (CDS) Financial Weapons of Mass Destruction. He talked about the problem of derivatives often early in the decade. He also paid good money to get rid of the derivatives book when he bought GenRE. Buffett talked about derivatives, the linkage, and how they provided systemic risk early in the decade. From what I know his predictions are coming true. He doesn't say much about derivatives anymore because I think he knows there is nothing he can do now, until this plays out. But when he offered his monoline deal he specifically didn't want the derivatives. SMART MAN, that Buffett. Way ahead of his time as usual.
Here's a little tidbit that puts the whole derivatives industry into clear perspective...let's call it the "Mortality Default Swap." This one makes me want to puke.
I'm surprised we haven't heard from any biochemists yet. Since the yolk is largely lipids and the egg white is protein (albumin), I'd guess that there is a procedure of solvents and centrifuging that would separate the two, with out really being able to reassemble them. Hmmmm, and I'm guessing if the analogy holds, the solvent is lots of money and the centrifuge is lawyers and regulators,...so it's all good,...
I studied that stuff in chemical engineering... that's why I suggested a chicken... feed the egg to a chicken, let her digest it to produce a new egg... only way guaranteed to work. Entropy & 'irreversibility' and all.
I think that analogy applies to the monolines too... chop'em up and feed them to other entities.
My summary of this lively discussion and some questions....
1) There is no equity in the monolines anymore. There are shareholders, true, but it's clear future liabilities are LARGE, CDS related and will wash away the shareholders who are entitled to RESIDUAL value.
2) It's not going to be a normal bankruptcy because of systemic risk to the muni bond biz - so the normal courtroom rules are subject to insurance regulators.
3) It's clear there is regulatory consenus that the muni bond insurance biz is a sound "going concern" that should be preserved to prevent a systemic shock.
4) Vultures are fighting over the remaining scraps. Some of these vultures are big and have nice suits. They are not used to being pushed about by insurance regulators.
Questions I have:
Who has priority claim over the assets of the "dead man walking" monolines AFTER the municipal bond insuance policy holders ?
Are there monoline bondholders ? If yes then what are they being offered...?
If CDS is not insurance how do their claims get treated, if CDS's are pay-as-you-go why can't they monolines stop writing new CDS ?
So much for the myth of insurance.
Insurance is, by nature, shared losses. If you can't share them, it isn't insurance and why the hell would you buy it?
How about applying the same principle to sub-prime mortgages directly. Split the mortgage into two parts. Assign 90% of it to a house's garage and the other 10% to the rest of the house. You can then have a "garage sale". Forgive me for the humor on such a serious issue.
Why does everyone keep assuming that the muni side is going to be safe and profitable going forward? If you strip them all out right now, put them in a pile what would happen? They'd generate no income and some of them would begin to rot. Got it? They are obligations. The "good" part is the capital upfront they had generated. The capital would have to go with the bonds. The capital is gone. That means the new "good" side of the split would also need to be recapitalized. Why would anyone do that when they could do the exact same thing but not have to take on the obligations as well? The only value in the muni side is the regulatory permission to write new muni bond insurance. How much is that worth? IMO less than nothing. I'm sure the municipalities are already casting about for alternatives to insurance given the recent massive price increases. They will go naked and take the hit with lower ratings or they will self-insure possibly. Even if there is still business to be had you can bet Buffet will get in the biz and eat your lunch.
Way up thread AllenM asks: What do you think California debt is really worth? AAA? Really? Or CAA? The need a major tax increase...
Let's be perfectly clear here as it applies to the future safety and profitability of the muni insurance business. There is not enough money in the entire State to satisfy the appetite of California's State and municipal spending desires. The absolute very worst thing that could happen is for the State to raise taxes. My first cut for the 2008-2009 State budget looks roughly like $96b revenues $140b spending. Yes, it really is that bad and most of the budget leadership is termed out of office this year leaving the mess behind.
Now how much would you be willing to pay for bonds backed by the State of California and insured by either the existing company or the "good" half of a split company?
The absolute very worst thing that could happen is for the State to raise taxes.
Really? I disagree. The State can repeal Prop 13 as it applies to commercial property, a purpose for which it was never intended. That would significantly increase tax revenue.
number2son writes:
Dawg says: The absolute very worst thing that could happen is for the State to raise taxes.
Really? I disagree. The State can repeal Prop 13 as it applies to commercial property, a purpose for which it was never intended. That would significantly increase tax revenue.
Fixing the corporate loophole in real estate would indeed raise many billions, once. aye there's the rub, the trick is self defeating. California is already pathologically anti-business. This would be the disincentive to end all disincentives. If instead you just change it for real estate going forward it won't raise any money for a long time and is still a business burden and new business obstacle.
Regardless it would only generate a few billions of the tens of billions current spending requires.
Don't get me wrong, I too am very much in favor of closing the corporate loophole. it is just that the current economy would require that for the time being it be offset with business tax breaks in a roughly net revenue neutral process.
I actually had a lot to say about this on my blog. It affects more than just the banks, although the banks are going to get hit very hard. Bear Stearns and Morgan Stanley are going to have a hell of a time (Bear Stearns has more exposure to Ambac and MBIA than they have equity capital).
The CMBS market, hence the REITs that need to refi high LTV, low cap refi loans this year and next are going to end up all over the front page of WSJ. Ambac and MBIA have a lot more CMBS than many realize.
The homebuilders will get hit. Centex has done a lot of business with Ambac, and I see about 15% of their equity lost on bifucation of the insurer.
Then, of course, there are the reinsurers. AGO just took on $28 billion of risk from Ambac. This thinly capitalized company gets 58% of is earned premium from structured products. It will get ugly.
it would seem per the statute that if an insurance company...
(i) buys a $10M AA corporate bond issued by company X with its reserves, that's a bond
(ii)buys $10M in treasury paper and sells $10M in protection on a AA corporate bond issued by company X, that sale of protection is (as a contract) an insurance policy EVEN IF THIS WAS DONE AS AN INVESTMENT
they are mathematically indistinguishable.
that's my point.
and...
(iii) buys $10M in treasury paper and sells a knock-in at-the-money put on $10M notional spx that's NOT an insurance policy
the fact that this doesnt happen every day doesnt mean it shouldnt be thought through...
because in example (iii) if the knock-in event is the credit default of a name, even though the payout is based on spx and not loss severity, that would be an insurance policy?
my point is not whether the statue is enforceable, its whether its intelligent and of what consequence that might be.
just consider the following
if an insurer DID sell protection as an investment, replicating bond returns and maybe picking up basis arbitrage, would it wake up one day to find out it by law had entered into an insurance contract?
thats what the statute says right?
do statutes have to be interpreted to give ridiculous results?
its insurance if the underlying knock-in event is credit failure but not if its, say, some financial index crossing a certain level.
Wow, Rob, your numbers make me feel good about my $40B CA deficit SWAG a few days back!
I don't know that too many are still arguing that the muni bonds are all that safe, just that the government's actions are totally motivated by self-interest.
p.s.: Futures up pretty good, so obviously there's nothing to worry about.
Fred, we are talking past each other. Part of my point is that the insurance company can't enter into mind-stretching transactions just because a quant says they are mathematically the same as investing in AAA bonds.
The other part of my point is that buyers of regulated insurance contracts have the regulators to fall back on when the insurance company does something stupid.
You can think about modelling equivalent transactions all you want. You'll probably have about twenty years to think about it before anybody is interested in buying any of those products again.
When we talk about muni bonds as being "the government" and how this deal is about preserving "the government's" ability to raise funds, let's remember who and what we are talking about here. I just got my property tax statement for 2008 and a big chunk of it will go to pay off bonds. No monorails; just voter-approved levies for new school and parks, backed by property tax revenue. If insurance regulators can help to work out a deal that keeps interest rates as low as possible for my city and my school district, that is okay with me. Personally, I don't want to see local goverments and local taxpayers suffer any more than necessary from the mistakes made by investment bankers and monoline insurance executives.
tj & the bear writes:
Wow, Rob, your numbers make me feel good about my $40B CA deficit SWAG a few days back!
Well if another $1200 of debt for every man, woman and child in the State makes you happy...
Quick breakdown. CA expects $109b revenue, Dawg predicts $96b. CA expects to roll over $10.5b existing unresolved deficit, Dawg predicts $7.5b. CA plans on robbing trust funds particularly transportation $4b(?), Dawg $1.5b tops due to legal challenges. CA wants to "save" $2b in Medi-Cal by cutting payments to doctors just because they think they can. Dawg thinks net will be +$2b in unintended consequences healthcare costs. CA plans on issuing previously approved GO bonds and maxing out several special use bonds to unused limits $13b. Dawg thinks price and terms and incompetence will get at most $11b. That's just the bad revenue assumptions. Don't even get me started on the spending side. They are already running a billion a month above trend and the underemployment consequences have not yet hit.
I don't know that too many are still arguing that the muni bonds are all that safe, just that the government's actions are totally motivated by self-interest.
Self-interest yes but all the proposals seem to assume the muni side is adequately capitalized. I don't see it.
"btw if im not mistaken cboe has exchange-traded cds contracts."
They actually trade credit event binary options - all or nothing payout ($100,000 per contract) based on whether the reference security has a credit event.
"i suppose the beneficiary is the exchange?"
The exchange makes money on transaction fees levied. Not sure who they have as market makers for these - Citadel, Timberhill, Susquehanna, Goldman?? dunno but that's who would be the other side of most of these trades and subsequently stand to make or lose money from trading with you.
Of the few they have listed the ones on Hovnanian seem the most interesting. The Sept 2008 expiration is
$20.50 bid by $24.50 offer
and the Sept 2010 expiration is
$78.00 bid by $86.00 offered.
These contracts have a 1,000 mulitplier so if you thought Hovnanian is going to have a credit event prior to Sept 2010 you could pay $86,000 for a contract that pays $100,000 if the default occurs. The market is basically saying default by Hovnanian is all but a certainty as this point.
FYI the reference obligation for Hovnanian is a bond with a 6 1/2% coupon with a maturity of 1/15/2014. I'd love to know what that bond is trading at...If the options are any indication those bonds should be trading at a steep discount to par...
John Stark says; Personally, I don't want to see local goverments and local taxpayers suffer any more than necessary from the mistakes made by investment bankers and monoline insurance executives.
Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt.
"Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt."
John Stark says; Personally, I don't want to see local goverments and local taxpayers suffer any more than necessary from the mistakes made by investment bankers and monoline insurance executives.
They are going to suffer mainly because they no longer have an artificial prop that will magically turn mid-tier debt into AAA for a cheap price. They will have to pay market interest rates to borrow money, like most companies do. Or, they will have to undergo more credit scrutiny and pay higher premiums to obtain strong bond insurance.
Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt.
There is the general public too Bob, these folks do provide services like water, sewer, police, fire... etc.
Even with things like water & sewer the period cost is covered by fees but capital cost is bonded.
And not everywhere gold plates services & salaries like California. In my world when bureaucrats make dumb decisions it effects both ends of the pipeline - tax payers & service consumers both get screwed (which in theory is really the same - taxpayer consumer of service - but few look at it that way).
It won't just be tax payers who suffer when this blows up.
This whole "crisis" has the air of bogosity (bogusness? bogositude?). Why are investors and fund managers depending on "ratings agencies" and "insurance" bought by the issuer of the scurities? Sort of like a movie studio hiring a review of their latest blockbuster.
As an investor, especially a supposedly sophisticated one, you are supposed to do due diligence and believe in what you invest in and take your lumps like a grown-up if you are wrong. It's no different from listening to stock analysts, who say "sell" at $3 and then change to "buy" at $15. This so-called "insurance" was phony from day 1.
Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt.
The point I was trying to make was that the government is, ultimately, us. I do have a hand to hold and I will suffer if my local governments have to pay more to build schools and buy parkland. Not all public debt is "ill-conceived," and on my tax bill, most of that bonded debt was created by vote of a 60 percent supermajority of the electorate.
If the monoline insurance was bogus from the beginning, good riddance to it. Without it, my local governments are going to be paying just a few more basis points on bond issues, using money provided by me. Not a catastrophe. My city, for example, should still be able to get bond ratings above investment grade without insurance; they often chose to issue bonds without the insurance in the past, because the premium cost sometimes did not justify the interest rate savings.
If you support police union, teacher union, prison guard union, and state employee union, please the due in form of union due and higher tax. Period. Don't blame wall street on your crazy spending. You get what you support.
A world in which some small municipality issuing securities in 2004 had to understand the risk of market collapse created by the highly complex and almost completely undocumented shadow banking system is not one in which humans can live. The credit system must be regulated to the point that normal people - without PhD's in economics or years of experience in structured finance - are able to make reasonable decisions about credit amongst the options available to them. Insofar as we can, we need to make good the mess created by failing to meet this standard in the past, and if this troubles some Cayman Islands hedge fund that bought CDS insurance from FGIC well, tough, the owners will survive.
Bundle up the "bad" part, spin it off as a new company called "Adventura", and offer it at $10 per share with a coupon for a 2 pound bag of Starbucks coffee.
California is one of the very few states that can borrow to cover operating deficits. The rest have to balance annual revenue and expenses. Thank goodness and good luck to sunny cal!
The flood of information is starting to be so much that average newspaper readers probably need to see novel headlines to even read another article about mortgages.
Consider this big news, which is buried in an article:
"According to the Mortgage Bankers Association, the delinquency and foreclosure rate for all mortgages is 7.3 percent, higher than at any time since the group started tracking that data in 1979." No Lull in Mortgage Pitches - NY Times
The gap between those who pay attention and the popular idea: Bernanke says bottom in late 2008 (!!??)....is large.
No it wasn't - it played a vital role within the context it was originally used - to spread risk over many smaller municipal offerings where no single one was large enough to warrant 'sophisticated investor' attention & resultant DD but in aggregate are sizable and to those residents important.
So you have a 1000 small municipalities offering up individual bonds... One in a 100 might go bad... but which ones? The insurers were supposed to do the DD and for a premium insure the lot... the investors then were 'sure' they'd get a safe investment and not have to tease through all these individual issuances.
Assuming the insurer did DD & used sound actuarial practices every thing was fine... and in the case of munis historically they have been fine. The system broke down with this CDO, CDS crap. The insurers didn't do the DD and they didn't practice sound actuarial methods (cause they didn't understand what they were insuring - they never should have gone there).
So now we are trying to tease the two apart and it isn't pretty.
Hopefully the industry will fall back on its 'roots'... small town & county issuance and stay the hell away from CDO/CDS... that is where Buffet will be soon & probably make a killing too.
Drayfly,
The default rate is more like 1 on 210 and even then it isn't a 100% loss. The historical losses were so miniscule I never understood the need for insurance in the first place. How many people carry meteor insurance riders? I can see the value of aggregation as you describe it but I fail to see how such a small risk exposure was financially engineered into such a large problem. Being a real engineer I think I see the problem; derivatives. First derivative = velocity, second = acceleration. There is a third derivative as Dryfly is well aware even though it isn't used very often. I've used it when analyzing thinks like piston motion and composite structures. For all those would be financial engineers out there cooking up third derivative products take heed of the name; jerk.
"Assuming the insurer did DD & used sound actuarial practices every thing was fine... and in the case of munis historically they have been fine."
dryfly- The munis were fine not because of the insurers, but because the munis inherently were and are fine (because of the dependable revenue stream). Muni bonds existed for centuries before anyone dreamed of insurance.
As far as the 1/100 going bad, in reality it's MUCH lower than that. And you can address it by putting together a diversified portfolio, just as well as with "insurance".
Entrusting your money to others may give some people a sense of security, but often times it is a false one.
Hopefully the industry will fall back on its 'roots'... small town & county issuance and stay the hell away from CDO/CDS... that is where Buffet will be soon & probably make a killing too.
But the whole story is that municipal bond insurance enabled a lot of excessive borrowing by marginal municipal authorities, well above prudent borrowing limits and for specific projects that lack the economics to repay their debts.
That's the next chapter in the story. So, wait for the whole story before you write the ending.
The Big Question is ultimately whether Bernanke, Paulson and Congress along with NAR can manage to somehow hold back the waters....
If they hold back the waters, then municipal bonds are OK. If not, it's a more complex story.
Can house prices be propped up? Only by increasing demand somehow. The easiest way to increase demand is somehow get house prices down enough and also the economy stabalized.
Isn't that an impossible combination? Perhaps there is a way.
Let prices decline some more, and then transfer all the mortgages possible (after writedowns) to FHA so the taxpayer absorbs further losses. This is probably the plan that will be most advocated.
Of course, in order to accept for instance 80 cents on the dollar for your underlying loan takes a great deal of awareness and toughness and planning for the securities holders, and how could that happen? So a unfolding royal mess looks more likely until finally they rush desperately to just that plan. Then you and I can hold the bag for any further declines thru tax liabilities.
I just wanted to thank everyone for helping me learn more about what's going on. Yes, we all love what CR and Tanta write and we learn from them. But we also learn from reading YOUR comments.
For all those would be financial engineers out there cooking up third derivative products take heed of the name; jerk.
Rob Dawg | Homepage | 02.18.08 - 12:07 pm | #
Rob - the only value was in the aggregation of risk for small issuers. Hell even NYC or Cook Cty Illinois or Orange Cty Cali are big enough they shouldn't need 'insurance'... people know where they are and can do the DD as AOTC suggested.
But what about Brown County Minnesota? If they want to put in rural water 'cause the ground water is bad who's gonna do the DD to buy those bonds?
Turns out I know a little about Brown Cty 'cause I drive through it all the time... reported average incomes are pretty low and would look like a bad bet on paper... except a whole lot of them are farmers who are land rich and cash poor with 2000 acre spreads most of which are owned nearly debt free... land out there is going for $4000 an acre. I'd bet on them paying the bonds back before I'd bet on Orange or Cook Cty!!
But you'd have to know and who has time to drive and ask questions in every rural county & muni?
So pay AMBAC a premium to do it for them and give them a rubber stamp and then you and I don't have to drive Brown Cty & do a head count of asset collateral.
Investor gets a nice safe return & Brown Cty gets rural water & AMBAC collects a premium - win, win, win.
That was what those things were originally for and those jerks blew it all up.
dryfly- If I were invesiting in Minnesota bonds, I would rather put together a portfolio of Brown County, a few other rural conuties, some Twin Cities suburbs, some St Paul, some Vikings Stadium, etc. I'd feel better about that than a "guarantee' from an opaque entity that I know nothing about.
But the whole story is that municipal bond insurance enabled a lot of excessive borrowing by marginal municipal authorities, well above prudent borrowing limits and for specific projects that lack the economics to repay their debts.
My experience is you will be wrong IN AGGREGATE. Some did but not enough muni losses to take down the whole system.
I mean property insurers made some bad bets insuring east cost coastal property too... and hillsides in Cali, etc.
But in aggregate property insurers mostly survive their losses, learn & rejigger the actuarial tables & do better DD next time.
Likewise with the monolines.
Going forward they will need to learn & charge some of the dicier munis more for a solid rating... or pass on them like property insurers do with brush country in Cali or beach property on the east coast.
Point is the muni bets they made weren't always smart but they weren't fatal. CDS bets they made are fatal.
Dry,
We are turning into a mutual admiration society. Exactly, aggregation for the small and Due dilly for the large. You may not like the looks of Cook Cty or The OC but my evil eye is on the PANYNJ. Those idjits seem to have been drinking the Wall Street brand Kool-Aid made with Hudson River water. 60% increases on the Geo Wash Bridge? [Side note; people don't know it generally but bridge tolls are considered transit fare revenue so when you hear that NYC transit users pay half their operating costs don't believe it.]
The more i think about it the more i dislike the idea of insuring munis. It increases costs and clouds transparency and induces poor financial behavior on the part of both parties.
I'd feel better about that than a "guarantee' from an opaque entity that I know nothing about.
The opaque entity needed to be less 'opaque'... they were at one time before the CDS crap clouded it all up. Muni insurance was pretty straight forward and easy to understand.
And as for Brown Cty... why insurance if they are so rock solid? Because the bonds go for thirty years and if you had a way back machine you'd remember Brown Cty wasn't so rock solid in the Farm Crisis (20 years ago). Who said it can't happen again?
Shit happens - that's why even responsible people have insurance. Insurance aggegates & smooths risk but it has to be well founded in actuarial practice & DD. Worked for munis for a long time - not for CDS.
Dawg-The bridge tolls were not about revenue (at least that was the story). They were supposedly hiked to discourage vehicle from coming into Manhattan. I don't think that worked, but that was supposedly the reason.
exactly - why insist on oversampling to confirm observation bias - CR is even handed and if he seems to be 'pushing' negative views a lens tint check might be in order...
AOTC- Not unlike people complaining about the MSM focusing on the bad. Well, that's what sells newspapers. Happy news in the face of problems gets you labeled "fluffy".
the larger point is what grounds exist for a takeover or similar simply to preserve a AAA rating of the insurance company.
i concur if the aggregate claims paying ability falls too low its fair game and i can reasonably concur that some kind of waterfall or liability based restructuring would be licit.
i also recall that in ny state insurers are not fiduciaries of their insureds.
but...
if its not a matter of severely impaired claims paying ability but to preserve a AAA rating so the muni issuers can enhance more cheaply than by paying market rates...
i just dont see it.
suppose i have key man life insurance. and i have partners as beneficiaries.
i agree that a serious threat to claims paying ability is ground for regulatory action but...
is my desire as an insured to be able to say to prospective clients, "hey, at our firm, our lawyers are covered by life insurance from a AAA insurer, so if anyone dies theres money to bring a replacement up to speed; now those guys over there, their insurer is only rated A..."
is THAT reason for regulatory action?
did the insurance policies the muni issuers bought guarantee the payment of principal and interest should they fail to do so or did they also guarantee that AAA credit enhancement would be a consequence of the policy?
somehow i doubt the latter.
so why would an imminent ratings drop to, say, A+ or A from AAA be ground for takeover?
of course, if it's a well-known "secret" that the real rating of these monolines is more like CCC, sure...
but then that's just one more reason to hold the ratings agencies in contempt...
but that would be off topic
still though am i off to say that a takeover based on impaired claims paying ability while the ratings agencies insist mbia is better capitalized than fgic is implicitly saying the ratings agencies are full of s--t?
dryfly-Where I see the disconnect with reality is the Port Authority paying 4.5% with insurance and then jumping to 20% because the bond insurers are in trouble. Even if the insurance came from God Almighty him/herself it doesn't justify a differential like that.
Amen Fred - I just can't see it either - especially can't see the justification in wiping out the equity of what is at worst an A rated Company. I think if these were Financial Guaranty Contracts, they merely guarantee the payment of P&I as and when due. Not CDS requiring posting of collateral in a downgrade (which is what sent Enron into BK on its commodity swaps). So if the CDO assets are transferred into a new subsidiary, even if rated A or BBB, so long as the insurance commish signs off, how can the banks complain. They are less sure that they will be paid? That is a long way from insolvency.
Aheadofthecurve writes:
Where I see the disconnect with reality is the Port Authority paying 4.5% with insurance and then jumping to 20% because the bond insurers are in trouble. Even if the insurance came from God Almighty him/herself it doesn't justify a differential like that.
The differential is fully justified by an open outcry market pricing of the instrument. They want to bump Motorcycle fares 66% and 75% to cover debt. As noted above they don't call it covering debt but it still quacks like a duck. That smells of desperation and the markets confirm.
They also have an interesting Constitutional test to face. They are attempting to charge more for cash than for their own scrip (E-ZPass).
Rob-Where's the Constitutional issue with the EZ pass? It's a discount for frequent users and they save on toll collectors salary. Ameritrade charges less to buy and sell on-line than by phone, because it lowers their costs. How is that illegal?
Rob Dawg - Constitutional test? Nothing of the sort. Half the arcades I went to as a kid had tokens that conferred some advantage over quarters. Oh, and FastPass on the tollroads here in orange county offers a discount for using their transceivers over using cash. Has for years.
Why in the world would the fact that something is happening have anything to do with it being Constitutional? Jeez, get with the new century people. What PANYNJ is doing is valuing its scrip more than the face value. Not legal. there are ways around this but they apparently cannot be bothered by playing by the rules. IANAL and I don't play one on the internets but this I know.
No, I never have tried to rent a car without a ccard. What does that have to do with the rental price? You pay more for cash? no, you are talking about something else in the contract.
Dawg: Why in the world would the fact that something is happening have anything to do with it being Constitutional? Jeez, get with the new century people.
Aheadofthecurve: Well, as we say in New York, "So sue me".
Exactly. The nice trooper with the big gun explains in the nicest terms that you either pay $4 in PANYNJ scrip or you pay $7 with some dirty Federale lucre or you go to jail where the cash and credit prices are by law the same. Where's Groucho Marx when you need him?
Rob-I'm sure you've heard of the tax protesters who walk into their local IRS and try to pay their taxes in pennies (legal tender). They get escorted out by security, these days probably to Gitmo. Don't try this at home.
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'Auction-Rate' Freeze Thaws a Little
High-Altitude Yields
On Safe Issuers' Debt
Lure Bargain Hunters
By GREGORY ZUCKERMAN and KAREN RICHARDSON
February 16, 2008; Page B1
One crisis-plagued corner of the credit markets shows glimmers of healing a little.
As more conservative investors shun "auction-rate" securities -- debt from municipalities and other issuers with rates that reset on a frequent basis -- some hedge funds and other sophisticated investors are nibbling, seeking bargains and opportunities amid the market's difficulties.
Ziggurat,
Guess it goes to show that greater transparency leads to more efficient markets. The media reported the horror of PANYNJ having to pay a 20% rate due to a failed auction - people who knew nothing about the auctions will now likely participate in the next - yields should drop.
AOTC,
I hear ya. Any tinfoil I wear is because of the aliens not the gubmint.
Pennies aren't legal tender above a certain amount and the way things are going even the zinc is likely to be worth more than face soon enough.
We get all kinds of down deep in the guts here at CR. My point really is a simple one. You cannot create your own currency. 4 E-ZPass dollars cannot equal 7 US dollars at the toll booth when you can also buy 4 E-Zpass dollars for 4 US dollars.
There is a larger Interstate issue as well. Clearly charging more for occasional users is both a commerce and equal protection issue.
Freakin' A the E-ZPass system offers discounts to Nets home games. Tell me this isn't discriminatory.
Like I said before there are remedies. One would be to eschew Federal assistance. Another would be tokens. PANYNJ isn't inclined.
Rob-When I go to NYC, which I only do about once a year, I take the Taconic Parkway to the Saw Mill River and then pick up the Cross-Bronx to the Henry Hudson. I pay no tolls that way and it's much prettier.
Aheadofthecurve writes:
Rob-When I go to NYC, which I only do about once a year, I take the Taconic Parkway to the Saw Mill River and then pick up the Cross-Bronx to the Henry Hudson. I pay no tolls that way and it's much prettier.
That was you? Must confess, I only do this every 2nd or 3rd year these days. The Taconic State Parkway and the Mass Pike thereon connected are artworks worthy of preservation. I still remember my dad driving to Florida in the mid 60s cursing the GW Bridge toll.
My point really is a simple one. You cannot create your own currency. 4 E-ZPass dollars cannot equal 7 US dollars at the toll booth when you can also buy 4 E-Zpass dollars for 4 US dollars.
Except you can. Arcades do it. Casinos do it. Airlines do it (frequent flyer miles). Gift cards. And many toll systems, including the one I use, already do what NY is doing. IANAL, but I guarantee you the courts have already looked at this and said "no problem". I suspect that the crux is that tokens/credits/certificates that can only be exchanged for a limited suite of items don't count as "currency". The point of currency is that you can buy virtually anything with it.
Fair Economist,
You are supporting my point. Gift cards have 1;1 or better dollar values. Same for casinos. Just try and exchange 4 "gambling bucks" for $7 US tender like PANYNJ is doing. You cannot because it is illegal. tokens and such are the acceptable cheat. Make no mistake I understand the workarounds and wouldn't bother fighting them. PANYNJ cannot be bothered with such and has instead gone ahead and created their own currency with asymmetric exchange rates to the US dollar.
upper right, use the drop-down menu to search by issuer, indicate "bond", will pull all of the outstanding issues, provide time, sales, and trade data.
headofthecurve writes:
By the way, they take Canadian money on the NY Thruway and many stores around here (Albany). Is that illegal?
Illegal no, unauthorized, yes. The PANYNJ says it accepts up t $100 US but US only. This is a loophole for some agencies you can freely exploit if you wish.
A fraudulent conveyance, also fraudulent transfer is a civil cause of action. It arises in debtor/creditor relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy trustees. The usual fact situation involves a debtor who donates his assets, usually to an "insider", and leaves himself nothing to pay his creditors as part of an asset protection scheme. However, it is not uncommon to see fraudulent conveyance applications in relation to bona fides transfers, where the bankrupt has simply been more generous than they should have or, in business transactions, the business should have ceased trading earlier to avoid giving certain business creditors an unfair preference (see generally, wrongful trading). If prosecuted successfully, the plaintiff is entitled to recover the property transferred or its value from the transferee who has received a gift of the debtor's assests.
There is an old equitable maxim: "One must be just, before one is generous."
[edit] Fraudulent conveyances or transfers in the United States
In the United States, fraudulent conveyances or transfers[1] are governed by two sets of laws that are generally consistent. The first is the Uniform Fraudulent Transfer Act[2] ("UFTA") that has been adopted by all but a handful of the states.[3] The second is found in the federal Bankruptcy Code. [4]
There are two kinds of fraudulent transfer. The archetypical example is the intentional fraudulent transfer. This is a transfer of property made by a debtor with intent to defraud, hinder, or delay his or her creditors.[5] The second is a constructive fraudulent transfer. Generally, this occurs when a debtor transfers property without receiving "reasonably equivalent value" in exchange for the transfer if the debtor is insolvent[6] at the time of the transfer or becomes insolvent or is left with unreasonably small capital to continue in business as a result of the transfer.[7] Unlike the intentional fraudulent transfer, no intention to defraud is necessary.
The Bankruptcy Code authorizes a bankruptcy trustee to recover the property transferred fraudulently[8] for the benefit of all of the creditors of the debtor[9] if the transfer took place within the relevant time frame.[10] The transfer may also be recovered by a bankruptcy trustee under the UFTA too, if the state in which the transfer took place has adopted it and the transfer took place within its relevant time period.[11] Creditors may also pursue remedies under the UFTA without the necessity of a bankruptcy.[12]
Because this second type of transfer does not necessarily involve any actual wrongdoing, it is a common trap into which honest, but unwary debtors fall when filing a bankruptcy petition without an attorney. Particularly devastating and not uncommon is the situation in which an adult child takes title to the parents' home as a self-help probate measure (in order to avoid any confusion about who owns the home when the parents die and to avoid losing the home to a perceived threat from the state). Later, when the parents file a bankruptcy petition without recognizing the problem, they are unable to exempt the home from administration by the trustee. Unless they are able to pay the trustee an amount equal to the greater of the equity in the home or the sum of their debts (either directly to the Chapter 7 trustee or in payments to a Chapter 13 trustee,) the trustee will sell their home to pay the creditors. Ironically, in many cases, the parents would have been able to exempt the home and carry it safely through a bankruptcy if they had retained title or had recovered title before filing.
Even good faith purchasers of property who are the recipients of fraudulent transfers are only partially protected by the law in the U.S. Under the Bankruptcy Code, they get to keep the transfer to the extent of the value they gave for it, which means that they may lose much of the benefit of their bargain even though they have no knowledge that the transfer to them is fraudulent.[13]
Some of the most egregious fraudulent transfers occur in connection with leveraged buy outs, where the management/owners of a failing corporation will cause the corporation to borrow on its assets and use the loan proceeds to purchase the management/owner's stock at highly inflated prices. The creditors of the corporation will then often have little or no unencumbered assets left upon which to collect their debts. LBO's can be either intentional or constructive fraudulent transfers, or both, depending on how obviously the corporation is financially impaired when the transaction is completed.
Although not all leveraged buy outs ("LBO's") are fraudulent transfers, a red flag is raised when, after an LBO, the company then cannot pay its creditors.[14]
[edit] Footnotes
^ The term fraudulent conveyance is included within the more general term fraudulent transfer, as a conveyance is more descriptive of the transfer of title to real property. Fraudulent transfer, however, includes all types of property and in the U.S., both are generally all governed by the same law. Therefore, the transfer will be used for the remainder of this section.
^ Promulgated by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1984
^ As of June, 2005, 43 states and the District of Columbia had adopted it. See NCCUSL website, NCCUSL Home. A complete copy can be found there or at http://www.stcl.edu/rosin/ufta84.pdf
^ 11 USC § 548. Much of the language of this section was adopted from the Uniform Fraudulent Conveyance Act, which is the predecessor of the UFTA.
^ 11 USC § 548(1); UFTA § 4(a)(1).
^ Under the Bankruptcy Code, insolvency exists when the sum of the debtor's debts exceeds the fair value of the debtor's property, with some exceptions. It is a balance sheet test. 11 USC § 101(32)
^ 11 USC § 548(2); UFTA § 4(a)(2).
^ This is done through the mechanism of avoidance of the transfer. 11 USC § 548.
^ 11 USC § 551
^ Within two years prior to the filing of bankruptcy - 11 USC § 548(a)
^ 11 USC § 544(b) allows trustees to employ applicable state law to recover fraudulent transfers. The time period under the UFTA is in most cases four years before action is brought to recover. - UFTA § 9.
^ UFTA § 7.
^ See, Gill v. Maddalena, 176 B.R. 551, 555, 558 (Bankr.C.D.Cal. 1994) (citing 11 USC § 548(c))
^ See, for example, Murphy v. Meritor Savings Bank, 126 B.R. 370, 393, 413 (Bankr. D. Mass. 1991), in which an LBO left the corporation with insufficient cash to operate for longer than 10 days.
This may be the Henry Ford moment where somebody forced the banks to 'fess up to their mess and the banks shut down for 6 months. I thought we'd see this after the elections but looks like Spitzer is taking the lead again.
first
bank writedowns, here we come.
I just don't see how the egg can be unscrambled without there being egg on everyone's face.
While I understand the objective (keep the muni side of the house writing), and I understand the State's interesting in this, I don't understand how this happens. How is the "bad bank" capitalized, because it has to be to some degree? At what level? Then the minute this gets spun off it gets severly downgraded?
If I were a counterparty to this, I'd be calling in a stable of lawyers. What this would effectively be doing is waving the middle finger at all the counterparty contracts that didn't relate to the muni side. How is that possible?
The gangrene starts to get cut out.
I see how it makes great sense for shareholdes, CR, enabling the good side to write more business; nice insight.
I do not see how it makes sense for folks who bought credit protection on MBSs and CDOs. I presume they relied upon the reputation of a proven bond insurer that had been in business for decades, weathering many storms.
Why is Lerach behind bars, when we need him front and center to mess this up and get this house of cards to tumble? We need a jailbreak!
Conceptually, it seems to me it shouldn't be that hard to divide up the proceeds from the muni premiums and the bogus CDO premiums and allocate the rightful share to each. You could argue about the process, but the basic concept seems sound.
Of course the CDO premiums will be woefully inadequate to pay the claims, but there is no obvious reason why the munis should have all their premiums go to pay for the sins of the CDO players. And there won't be any sympathy for the CDO players because virtually everyone was complicit and played a part in creating the disaster.
This action has to be illegal. An insolvent instutition cannot makes itself solvent by "signing away" it's losses to a new entity. Contracts were signed in good faith. The pros did their DUE DILLIGENCE. This is why corporate bankruptcy exists. Liquidation of assets is part of the process. Another shmorgasborg for the attorneys.
Yes, albrt but a business uses profitable parts to fund other initiatives that may or may not turn out well all the time. This seems to be a question of mis-pricing risk. Back when those contracts were written risk was modeled to be one thing. Now the risk on these contracts is much greater and it is known that the risk is greater and was mis-priced on the original contracts.
So you just can't split it apart on the original assumptions without legal issues about what you know. If I were a counterparty here, and they tried to do this I'd be first in line to sue trying to get whatever I could out of them. They should be paying for that mis-pricing from any other profits they have, even if it's from the muni side.
If the CDO side is left undercapitalized and unable to meet its obligations when due, the transaction would raise a bunch of legal issues, such as fraudulent transfer concerns. You can't legally keep all the good stuff and leave creditors of the bad side (beneficiaries of the CDO insurance) holding the bag. Even if the CDO types are evil and unsympathetic.
Unless, of course, the regulators decide to make it happen.
There is only one way to unscramble a scrambled egg... that is to cut the scrambled egg into little pieces and feed it back to a chicken to digest and then lay a fresh egg.
What doesn't get digested gets 'passed' by the chicken in a different form - good fertilizer too.
Sounds a lot like bankruptcy to me. I think in the end that will be how this egg gets unscrambled too... those with claims to CDO coverage will not let go without one helluva a fight and it will drag all affected parties through the bowels of bankruptcy.
Given the trillions in credit default swaps, could it be that every bit of the real debt is hedged 6 ways from Sunday and the insurers are just one of the 6... Gotta be at least 5 other gamblers out there.
Wall Street is no better than Vegas, except that nobody has a complete grasp of the rules, the odds are unknown and there is literally NO limit to the betting...
Wall Street is no better than Vegas, except that nobody has a complete grasp of the rules, the odds are unknown and there is literally NO limit to the betting...
Worse actually... at least in Vegas there are large breasted girls walking around showing cleavage & bringing you drinks while you lose your money... hey wait, maybe that was CNBC I was thinking of instead.
Never mind.
Conceptually, it seems to me it shouldn't be that hard to divide up the proceeds from the healthy patients and the bogus cancer patients and allocate the rightful share to each. You could argue about the process, but the basic concept seems sound.
As was pointed out in the last thread, perhaps this isn't a precident that should be set. If there is an underlying legal structure that separates the muni and CDO risk pools, then everything is different. But I haven't seen that mentioned.
suggest those of you interested in this read up on "liability based restructuring."
there is a lot of precedent for this in the banking area.
there is not much in the insurance area.
in addition i am still unclear whether the cds contracts on which these monolines sold protection are legally insurance policies or simple securities making their customers simple unsecured creditors and not policyholders.
Where's Harvey Pitt on this? I vaguely remember he was representing hedge funds who were claiming that they were getting burned by manipulators of the CDOs that the hedge funds were protecting by writing CDS. A feast for lawyers.
My guess is that if this stuff gets too messy, Congress will make the splits legal. If municipalities and states can't borrow money on reasonable terms because of the monolines, something will get done quick to restore order.
All of a sudden we have a bunch of legal experts here! Great!
Regardless of the outcome -- downgrade vs. quick "split" fix vs. massive legal quagmire -- I don't see any way this is going to be good for the markets.
Guess it's time to go massively long.
what really depresses me is that the state govt's are doing whatever they can to preserve their access tocapital markets but they'll fail too. now the symptom is the lack of insurance on the bonds, but the very fact of "insurance" is the moral hazard in the system because it encourages irresponsible borrowing. When the state govt's has destroyed the banks, who will provide the capital for their bonds? what funds will have the capital to buy them? and how can the state governments point to higher revenues when their own finances are screwed because real estate transaction taxes and property tax incomes are devastated!
All of a sudden we have a bunch of legal experts here! Great!
Don't you know... We're all legal experts now.
Not sure if it's just me but I can't bring up David Merkel's The Aleph Blog.
So I will paraphrase his money quote:
"Anyone else trying this would be committing fraudulent conveyance, but I guess when you have state government behind you it's called public policy."
Basically he is saying NYS cannot act in such manner so as to throw one set of policyholders under the bus.
He expects instant litigation on the part of the IB's.
If he is right and NYS cannot successfully counter-argue I would expect that enough capital would have to be deposited in the structured-finance newco to satisfy IBs.
And I am wondering if the muni newco might start out with no capital e.g. the newco would be capitalized completely with fresh funds while the s-f newco would be in "runoff" mode.
My other thought is that, given Dinallo's admission that he asked Buffet to appraise a deal to buy time over MLK weekend, Dinallo may have put this forward to buy more time.
May I split the non-profitable segment of myself from myself? Isn't that the Star Trek where the evil Kirk takes over?
Game theory will provide the 1st plan of action, legal pecedent will provide the 2nd, the spanish concept of "buttfucking*" will be the final plan of action.
*this refers to the willingness of one party, even in a position of strength, allows a less than optimum outcome from his position because the binary outcome is worse for both parties in the long run.
blowncue,
Correct me if I'm wrong, but wasn't it established that the muni premium is paid in full up front, whereas the non-muni premiums are paid over the life of the policy? If that's the case, there's no way they can leave the muni side with no capital is there?
the newco would be capitalized completely with fresh funds while the s-f newco would be in "runoff" mode.
...that runoff is likely to be a very short race even with capital.
Off topic: Iron Ore is up 65% for next year.
The two articles stacked on Bloomberg contradict each other as to whether this is good news or bad news.
NSA is onto something, but I'm thinking of property settlements in divorce. I'll split off my valuable stuff (house, boat, BMW, cottage, jewelry, etc) from my lousy stuff (credit card debt, student loans, what I owe the landscapers and cabana boys) and my ex gets to choose from the latter category.
The two articles stacked on Bloomberg contradict each other as to whether this is good news or bad news.
Makes sense - depends on whether you are buying or selling.
BTW - I work in 'base metals' - confirms what I see too.
Dinallo is basically trying to patch together a deal that gets the Muni market functioning again.
What do you think California debt is really worth?
AAA? Really?
Or CAA? The need a major tax increase...
Now, if the Muni markets go totally south- you can wipe out the entire IBank community- including state shops and regionals.
Plus you will have how many senior citizens thoroughly pissed off at their congress critters. Ask Chuckie Keating how wise that was.
So now we have yet another bailout that is supposed to lead to containment.
My property tax FCV fell from 507k to 428K for my '09 valuation. Maricopa County Bonds anyone?
Citibank should be overjoyed at being 73K over the assessed valuation.
Comforting thought that all these fools think I am tapping my retirement to pay their bills!!!
Someday this war's gonna end...but right now it looks like another couple of years....
Roubini on muni defaults
(free registration required, I'm just excerting a bit):
The relative safety of muni bonds is based on the relatively low rates of default on their bonds in the last quarter of a century. But there are several reasons to worry that default rates by state and local governments may sharply increase during the coming US recession.
First of all, the previous two US recessions in 1990-91 and 2001 were relatively shallow lasting only 8 months - and did not affect as severely the finances of municipalities...
Second, state and local governments rely heavily on three sources of revenues: fees paid by real estate developers; property taxes; and sales taxes...
Third, an economy-wide recession will have much more severe effects on the fiscal conditions of state and local governments in regions where the housing boom and the home prices bubble were particularly large...
Fourth, many state and local governments will have very large fiscal financing needs in the next couple of years.
The "good" side may not be so great, either.
So now we have yet another bailout that is supposed to lead to containment.
Come on Allen, its gettin' there... contained that is.
And I am wondering if the muni newco might start out with no capital e.g. the newco would be capitalized completely with fresh funds while the s-f newco would be in "runoff" mode.
That's what Buffet proposed.
And the payout on CDO insurance is pay as you go - not marked to market payout.
Most of the business splits I recall happened to try to juice the stock of the original entity by unloading the part(s) considered underpeforming. None of these, I recall worked particularly well.
With these insurers, that ship has sailed. There's no way to get the stink (liability, crookedness) off the supposedly good side of the business.
Buffet's plan makes more sense, and seems at least somewhat likely to be able to restore some stability to the govt markets.
If it works, the banks melt but the muni market doesn't. Fine, we'll see.
I hereby announce that I will be separating myself into two persons! The first, "Peripheral", will take responsibility for the student loans, credit cards, and rent payments. The second, "Visionary", will take responsibility for the salary, clothes, computer, and retirement fund.
Now I just need to put together the paperwork to make it all happen. If companies can do it, why can't individuals?
The Residential Real Estate Crash Index Message Board - Msg: 24318880
I think this link will bring up a copy of the text of the Aleph blog post I cited.
TJ: Admittedly I am talking out of my ass here. I'm just wondering if it's possible to split the b-i's into two newco without both newco having sufficient capital if the fraudulent conveyance objection has any traction.
I don't know insurance law so I don't know if fradulent conveyance applies to policyholders as opposed to creditors or whether it can extend to any party under contract.
What does surprise me is that Dinallo did not address capitalization of the s-f newco on Friday.
To answer your question I should rephrase: the muni newco would be capitalized out of the gate with fresh capital of such amount to satisfy municipal policyholders.
Or, Dinallo and Spitzer are playing a Big Game of Poker with the aim of getting b-i's to voluntarily split.
I agree that a split would be illegal. The existing shareholders would need to be wiped. This would need to function as a defacto BK. That way new capital could be raised for the solvent side of the split with a clean slate and no entanglements from the IBs. The new capital would fund defaults on the muni side while the esisting capital would fund the IB side followed by a quick default.
I thought a good question was asked above, that no one has ventured an answer to. Do credit default swaps legally count as insurance?
While everybody is focusing on MBIA/Ambac, here came a news from down under.
ANZ Drops as CEO Says Credit `Bloodbath' Cuts Profit (Update3) - Bloomberg.com
"ANZ spokesman Paul Edwards confirmed the insurer as New York-based ACA, which had its rating sliced 12 levels to CCC by Standard & Poor's in December, casting doubt on more than $75 billion of debt the company guarantees, including $69 billion of securities such as collateralized debt obligations."
Will "bad bank" that spun out from Ambac get better than ACA? I don't think so...
Now, if the Muni markets go totally south
I'm sure you really meant "when".
Of course, the whole split concept could be just another delaying tactic during which various bagholders unload what they can or otherwise mitigate their upcoming losses.
Previous post apparently eaten by haloscan - sorry if this turns out to be a duplicate:
It is important to recognize that we are not talking about a solvent entity here, so we are not talking about retribution for whatever the insurer may have done. As a practical matter, it doesnt matter what type of coverage people thought they were getting because the company that made the promises no longer exists. We are only talking about how to divide up the assets, and whether it is possible to increase the total assets by creating a solvent insurance company out of part of the wreckage.
It is like bankruptcy, except instead of going to bankruptcy court the actual insurance companies are controlled by state regulators. It is not uncommon for an insurance company to accept control by state regulators even if there has been no formal determination of insolvency. The state regulators primarily care about policy holders. Creditors and stockholders get what is left over (generally nothing) after all policy claims have been satisfied (which can take many years).
But the regulators dont necessarily have to treat all policy holders equally, and in fact they cant given the different types of policies that charge different premiums and are designed to do different things.
In this case, you have municipalities that mostly played by the rules, and mostly paid premiums that were reasonable under the circumstances. I think most people (including the state regulators) would agree they should get what they paid for. That doesn't mean the muni side won't become insolvent, but the runoff should at least be somewhat orderly.
On the other hand, you have the Ronco Bond-O-Matic industry in which all the players were either as crooked or as foolish as they could possibly be. They paid premiums that were completely inadequate to cover the risks involved. I think most people, (including the state regulators) would agree they should also get what they paid for. If investors suffer additional losses after the insurance money is gone they should look to the people who created these things and misrepresented the risks involved.
By the way, in case the implication above wasn't clear enough, the stockholders in these companies have already been wiped out. Some of them just dont know it yet.
I think CR's opinion that the "good side" of Ambac can go back to writing a stream of new muni biz is wildly speculative. There will be a legal cloud over the "good side" for some time, and their claim of in-house credit analysis and "zero loss" standard is forever shot. The good side will be downgraded below AAA soon, and as the recession deepens the good side will have its own flow of muni defaults to deal with. Most issuers aren't so desperate for insurance that they will just start throwing money at Ambac again.
To Keep It Simple, I'm Stupid:
(that's somebody's moniker, not a self-revelation
)
Here's a post from Yves Smith over at Naked Capitalism all about credit default swaps.
Credit Default Swap Worries Go Mainstream « naked capitalism
The munis were never the major problem. Yes, the munis can be saved. But that does nothing for the real problem...the mortgage securities insurance.
If anything, spitting into two businesses will pull the last mask off the charade. Party over. Time for everyone to go home, lick their wounds, and nurse the hangover.
albrt: On the other hand, you have the Ronco Bond-O-Matic industry in which all the players were either as crooked or as foolish as they could possibly be.
But let me say that we would not be in the quandary we are in now if Ronco really was in the bond industry. At least his products, whatever they are, work as intended. I'll take a Ronco Bond-O-Matic over a CDS any day of the week. Plus, you get a free baldness cover spray with it! But wait, there's more!
While we are focussing on the death throes of the monolines,I wonder what will be coming out of left field in the next few days or weeks.ABCP was a surprise last summer,and it feels like it is time for our next surprise guest.
OT: I wish the Onion reported on the markets more often... I'd totally quit MW & Bloomberg if they did...
Asian Markets Fall Like Cherry Blossoms In Gentle Spring Rain
"Fading dollar's gleam, a feeble warning beacon: Seek bellies of pork"
I wish the Onion reported on the markets more often
Great find -- thnx. :>)
"tj & the bear writes:
blowncue,
Correct me if I'm wrong, but wasn't it established that the muni premium is paid in full up front, whereas the non-muni premiums are paid over the life of the policy? If that's the case, there's no way they can leave the muni side with no capital is there?"
The prepaid muni premium is in the unearned premium reserve -- about $1.4 billion for FGIC and $3 billion for Ambac.
This isn't capital but a liability for the combined company.
"j writes:
And I am wondering if the muni newco might start out with no capital e.g. the newco would be capitalized completely with fresh funds while the s-f newco would be in "runoff" mode.
That's what Buffet proposed."
The Buffett proposal was to take the unearned premium reserve plus capital equal to 1/2 or 1.5 x the unearned premium reserve. To that, he would add additional capital. This would put the new company at true AAA levels.
Any of the new proposals would have to be better then the Buffett proposal. Buffett would have left most of the capital in the old/bad entity and put the new entity clearly up to AAA levels. The holding companies would have gotten no benefit (hence the pitch to the regulators and public instead of the companies).
Warren Buffett's letter to bond insurers - MarketWatch
It will be interesting to see who benefits more from the new proposals -- management, stockholders, or non muni insureds. If all the benefits go to the bad/old company insureds/policyholders, then it makes sense. If not (which I strongly suspect), then it will be interesting to see who is trying to grab what.
Frankly, I don't think Buffett cares very much one way or another. He made a bid to clear the decks on the whole mess. If other people want to throw a lot of capital into the muni business, then he has other opportunities to allocate capital. This is a great time for deals if you have plenty of cash. If they try to capitalize the new muni companies thinly, then his company which is a solid AAA will get first shot at new business.
The word "split" seems to be causing some confusion. The end result is to get the muni side on the market working again. Buffett appears to be willing and able to do this. The response to a systematic crisis doesn't have to be legal, it just has to fix the immediate problem. Shareholders and IB's be damned. That mess will be addressed after the muni's are fixed.
To Keep It Simple, I'm Stupid:
(that's somebody's moniker, not a self-revelation
)
Here's a post from Yves Smith over at Naked Capitalism all about credit default swaps.
That's nice. I know what a credit default swap is. However, I had a very specific question, and your link doesn't answer it. Are credit default swaps, legally an insurnce policy. I'm not asking what they are in practice; I'm asking how they get treated in a technical sense.
There are a lot of things about a CDS that work like insurance. There are also a lot of things about them that don't.
KIS,IS:
Your question is your answer, Grasshopper. Basically, if it is regulated then it is insurance. If it is unregulated it is CDS. We appear to be talking about insurance with AMBAC.
"Are credit default swaps, legally an insurnce policy. "
I think not.
I remember reading that they are derivatives and subject to derivative accounting -- i.e. mark to market -- which caused MBIA a lot of their problems.
However, somehow they managed to get entangled in the statutory insurance companies.
We appear to be talking about insurance with AMBAC.
Why does it appear that way? We know that Ambac is regulated, but we also know that it writes things that are quite clearly insurance policies.
Rumor... but on topic...
Good Bank - Bad Bank Rumor: [Rumors] - MarketTicker Forums
...That the banks which would be screwed by having their CDO's stuck with the insurance from the "Bad Bank," instead of tying it up in court for God knows how long....
The word NOW is that these banks are being offered equity in the "Good Bank" to make them "whole."
Spitzer and FGIC & ABK tried to end-run the banks, got threatened with "Instant Litigation," and will now end-up giving over to these same banks the very pieces that Buffett would have paid a significant amount of Jing for just a few days ago.
Oh, and albrt, thanks for being really condescending.
if you think this is so simple or obvious or for that matter without massive import...
if a monoline insurer wrote an out of the money cash settled knock-in put on the spx to make a little money, would that be insurance, and the counterparty an insured/policyholder?
get it?
no one anticipated this when they allowed the monolines to "insure" this stuff...
you tell me what the difference is between an insurance policy and an investment with an embedded put...
classically insurance is reserved and funded by aggregate variance reduction, meaning a life insurer holds a book of so many lives that the probability of having a significant deviation from expected profit (premium minus loss) is nil...thus the risk is retained but minimized by the law of large numbers.
thats a bit damn different from just contracting that "you pay us $x every quarter unless soft default credit event X occurs then we pay you $y"
or is it?
are all contingencies insurance?
its not a joke.
and incidentally im a securities and tax lawyer and a quant and i dont have an answer. i dont practice in insurance recovery but i have colleagues who do and id be amazed if theres a cogent answer.
and "if the company is regulated then its insurance" isn't. this isn't a case of the simpler the better.
I though the main question is: if they get split the good part is going to be deal with as aaa or not? on top of all the legal issues of the split.
JBR writes:
Rumor... but on topic...
[...]
The word NOW is that these banks are being offered equity in the "Good Bank" to make them "whole."
So they would wipe out existing shareholder equity but give banks a piece of the new entity?
While I would be the last one to claim that something as mundane as bankruptcy law would be enough to stop Elliot Spitzer from over-reaching, I doubt a simple grab of the assets away from the structured finance policy holders is what is contemplated.
I think the model that may be invoked here is something along the lines of the asbestos trusts that used the equity of the defendent firms to generate capital to fund the trusts. In this case, a muni newco is formed, perhaps with some new outside funds, but with the balance of the equity being reserved for the existing structured finance policy holders. At some point down the road, the equity in muni newco is monetized and those funds are used to help pay the claims of the structured finance policy holders.
At the end of the day, it is unlikely to be enough to satisfy all the claims of the structured finance policies, but it is probably the best hope of generating capital with which to pay those claims - let's face it there are no sources of capital that will step up and fund the structured finance side of the business.
The muni side of the business is viable if it can shake free of the non-muni toxicity. If that can be achieved, then the franchise value of that business can be monetized down the road. If things stay on the current course, there will be no value left in the muni side of the house when the whole thing goes into run off. Of course the current shareholders would be wiped out in a plan like this, but the management teams will probably go along with it as long as they get some options and a job in newco. Better that than a slow an ugly death in run off.
It appears that the structured finance liabilities which were written in the "transformer" entities are guaranteed by the parent orgs (according to the WSJ) so it seems unlikely that there is any effective ringfencing that can be done here without some kind of consent of the policy holders.
Spitzer needs something to happen quickly, they will cut some kind of deal that gives the CDO owners a reason not to sue.
and incidentally im a securities and tax lawyer and a quant and i dont have an answer. i dont practice in insurance recovery but i have colleagues who do and id be amazed if theres a cogent answer.
fred - I commented on a different thread yesterday or the day before that I wouldn't be surprised if this goes all the way to the supremes. That is unless there isn't a case by then 'cause all the litigants are 'dead'.
Seriously - I see no way this ends cleanly until all pockets are empty.
the easiest way to avoid all the lawsuits would be to downgrade the whole companies, let them go BK, and then call in Buffett to pickup the muni bonds at firesale prices. forget the CDO's.
Remember that you all heard it here first, this is desperation, posturing, and the last ditch effort to salvage the existing equity.
Take a step back and look at the recent unfolding of events, will not raise new capital, Fitch downgrade, scoffs at the Buffet proposal, emphasizes the claims paying ability of the existing entity, statement from the regulators in regard to a potential split if capital is not raised through a market-based solution, all of a sudden they are potentially splitting in two on their own.
Bullshit, this is posturing, nothing more, nothing less.
I also find it interesting that MBIA had made various previous statements surrounding their exceeding the ratings agency rating requirements for AAA, noticibly absent from the congressional testimony were like statements.
Things are changing very rapidy, I would expect this to continue next week as well.
I have stated what the solution should be at any cost, problem is that the current participants ain't gonna like it.
the easiest way to avoid all the lawsuits would be to downgrade the whole companies, let them go BK, and then call in Buffett to pickup the muni bonds at firesale prices. forget the CDO's.
Even that won't be 'fast enough' to save anything really... a pre-packaged BK will still take many months to go in and out of BK... even if everyone agrees.
They got months?
I think the model that may be invoked here is something along the lines of the asbestos trusts that used the equity of the defendent firms to generate capital to fund the trusts.
How long did the asbestos settlements take for everyone to see the light, capitulate & sign on? It was years wasn't it?
They don't have years.
if they don't let them go down there will be endless litigation. if they let the go bankrupt then the aaa should be lost for all insured entities.
The White House pushed through "Tort Reform" in response to asbestos liabilities, the Class Action Fairness Act of 2005.
KIS,IS:
Sorry, I didn't intend to be condescending. I was trying to get into the spirit of the Onion article.
I have not researched any details concerning these particular companies, but regulated insurance companies generally can't just say they are writing something other than a true insurance policy in order to avoid regulatory requirements.
They also can't take their reserve funds and invest in speculative, unregulated contracts like most credit default swaps. Their reserves have to be kept in very highly rated bonds. Given the problems with the rating agencies some of those bonds may not be so great after all, but they probably aren't credit default swaps.
The holding companies or other non-regulated affiliates may have "invested" in CDS, but that is not who the regulators are talking about splitting.
Fred:
I will stick with my answer, without posting my credentials to mislead people into thinking this is legal advice. I think it is a pretty good rule of thumb.
It is one thing to analogize an unregulated investment contract to "insurance." It is quite another to claim that it really is the same thing as insurance. In fact, I would say that a good percentage of what has happened in the past five years is that the high-speed Wall Street folks apparently forgot what an analogy is.
A purportedly inverse-correlated investment contract is a "hedge." It is not "insurance" unless it has the safety features associated with boring old insurance companies, including a known place of business, strict reserve requirements and a legitimate regulator.
They don't have years.
--- Spitzer would like to have this ---
Kirk asks for a damage report from Enterprise. Spock reports that "by the book, hours would seem like days" and that transporters will be available in two days.
-- The truth is likely to be more like this --
He's dead, Jim.
I just don't see how screw the equity is the correct solution. Contrary to the postings here, Dinallo and Spitzer have made it clear that the issue is not about solvency, only the need to maintain a AAA rating for the sake of the muni market. How that translates into wipe out the equity and give it to the banks is beyond me. Did Ambac ever agree it would maintain a AAA rating? I doubt it. It seems to me you could capitalize both entities and each would remain solvent. Admittedly, the CDO ratings would suffer, but if this Company was purely in the CDO business that would have happened long ago - the muni side was propping up the CDO ratings.
Why should the banks get anything?
Why AMBAC (and the other monolines) as a regulated insurance company was operating the unregulated derivative contracts called Credit Default Swaps to "protect" (I didn't say insure) the subprime CDO derivatives? They got caught, didn't they?
Dryfly,
That is a very good point. There are a lot of cats to herd here.
On the other hand, the tort bar had every incentive to spend time trolling for every possible asbestos claimant out there (and the rate of medical inflation may have also been an incentive not to settle quickly - if you were a lawyer). I think there is a greater sense of urgency here on the banks' part. The jig is up on the AAA ratings in the current monoline configuration. I think (I'm speculating) the banks are better off with a AAA muni entity in which they can own most of the equity rather than hoping for the best from something that is in runoff.
I don't know much about the latitude of insurance regulators, but I'm guessing that body count in the auction rate note market will push Spitzer toward a deal that doesn't face months of litigation - so there has to be something in this for the structured finance policy holders.
I think that the hole point has been lost in the argument dinallo and sptizer want to save the minis therefore they are trying to save the aaa on the munis, if the companies are split be split to be save are you going to put your money in munis insured by new old or any of the 2 new?
Did Ambac ever agree it would maintain a AAA rating? I doubt it.
I don't have a link handy but I think the answer is 'yes they did'.
The assets they insure only carry AAA ratings as long as the insurer that insures them maintains their AAA... if the insurer falls so do the insured assets... and the funds holding those assets (pensions and other insurance funds) are required to hold ONLY high rated funds... so they dump those assets en mass if the 'chain reaction down grade' occurs and that starts with the monolines.
Why should equity get hosed is a different matter - I personally don't see how they do get hosed until some kind of due process gets completed... either bankruptcy or regulatory event. Either way 'due process' takes a bunch of time... for the first finding and then all the subsequent appeals.
Just my guess.
Asia-Pacific Bond Risk Increases on Proposal to Split Insurers
\t\t
By Denise Kee \t\t
Feb. 18 (Bloomberg) -- The risk of Asia-Pacific companies
and governments defaulting on their debt rose on concern that a
proposal to split U.S. bond insurers may spark further credit
losses, credit-default swaps show.
as a lawyer i wouldnt dream of giving legal advice without careful analysis and a big retainer. as a quant i can give mathematical advice, because it's wrong or it's not.
here it be:
mathematically, insurance and derivatives are indistinguishable. both are methods of contracting for payments in whole or in part depending on contingencies. hence the concept of "life contingencies" (derivatives) or "contingent claims"
i dont argue for a minute that a verbal definition can be attempted.
but that doesnt mean it has mathematical validity.
if your position (this is a debate, not an argument) is that by allowing a monoline to sell protection on a cds, then that is insurance by definition, then watch:
(nothing up my sleeve):
assume for simplicity (im not being coy, the details dont change the thrust) that a credit event in a cds is the same as an actual default such that holding the physical security (bond or bond equivalent) would suffer, then riddle me this:
monoline X sells protection on a AAA tranche of something, say a CDO.
monoline Y doesn't touch the stuff. pure as the driven snow. they just insure (or "insure") munis.
of course monoline Y has to invest its reserves, so it invests its reserves in a mix of corporates and munis.
i submit that monoline Y, by investing in a AAA corporate bond, has just taken on the mathematically identical risk of monoline X.
so does that mean every time you buy a bond from someone you've just insured them?
this isn't silliness, and indeed if there were an identity of soft default and physical default then the two positions would have to be identical (assuming identical names/credits, or that AAA risk is fungible) or there'd be an arbitrage (cf. negative basis plays).
my point is that to say that its insurance because its risky and thus its not an investment because they have to hold their reserves in super safe investments isnt going to work because selling protection on a AAA cds should be LESS risky than almost all the bonds the monoline is holding as reserves, no?
to argue with that is to take a position that it was always known or knowable that the AAA on a cds was bs...
in which case why would the regulators allow it to begin with?
much of law as you well know involves distinctions without a difference
but this time its going to be a hugely visible mess.
oops
i meant life contingencies (insurance) or contingent claims (derivatives)
sorry, its late
Keep It Simple:
I came across three items that make a distinction between financial guaranty insurance and credit default swaps. My best guess is that financial guaranty insurance policies
(1) need to be issued by an entity defined as an insurance business per a given state's insurance regulations, and
(2) provide for performance in the event that a financial debtor fails to pay despite its obligation due to default or insolvency.
Excerpt from MBIA response to Ackman's letter to regulatory authorities:
Alea | Page not found
"...All financial institutions who take and manage credit risk in buy and hold positions are required to make estimates of uncollectibility or credit impairment. MBIA has a rigorous process for determining the amount of credit losses in our portfolio of financial guaranty policies and our CDS contracts (it must be remembered that our CDS have the character of financial guaranty insurance policies, not tradable CDS as transacted by most market participants). The process of recognizing loss on our contracts for statutory reporting is governed by SSAP 5, which is consistent with FAS5 (Accounting for Contingencies). Our reserves are based on reasonable estimates of probable losses, in accordance with the guidance. There is no provision in GAAP or statutory reporting for reserving based on worst case hypothetical losses. In no way does the fact of internal estimates permit a bond insurer to “determine statutory capital.”
[Note that MBIA did not say it was a financial guaranty policy, only that it had "the character" of one.]
A definition of financial guaranty insurance:
Wolters Kluwer Financial Services – Page Not Found
A definition of suretyship:
Wolters Kluwer Financial Services – Page Not Found
Except from NYS Insurance Office of General Counsel Opinion regarding financial guarantee insurance:
N.Y. Ins. Law § 6901(a) (McKinney 2000) states in relevant part:
(a) (1) "Financial guaranty insurance" means a surety bond, insurance policy or, when issued by an insurer or any person doing an insurance business <b> as defined in paragraph one of subsection (b) of section one thousand one hundred one of this chapter,</b> an indemnity contract, and any guaranty similar to the foregoing types, under which loss is payable, upon proof of occurrence of financial loss, to an insured claimant, obligee or indemnitee as a result of any of the following events:
(A) failure of any obligor on or issuer of any debt instrument or other monetary obligation (including equity securities guarantied under a surety bond, insurance policy or indemnity contract) to pay when due to be paid by the obligor or scheduled at the time insured to be received by the holder of the obligation, principal, interest, premium, dividend or purchase price of or on, or other amounts due or payable with respect to, such instrument or obligation, when such failure is the result of a financial default or insolvency or, provided that such payment source is investment grade, any other failure to make payment, regardless of whether such obligation is incurred directly or as guarantor by or on behalf of another obligor that has also defaulted[.] (emphasis added)
Thus, the principal distinction between financial guaranty insurance and surety insurance generally rests on whether the primary obligation guaranteed is a financial debt (such as payment of a deposit) or is some other type of performance (e.g., delivery of goods), unless it comes within one of the other provisions contained in N.Y. Ins. Law § 1113(a)(16) (McKinney 2000), such as subparagraph (D) or (E). Hence, the contract that was denominated a "surety deposit bond" in the firm’s inquiry is financial guaranty insurance under the New York Insurance Law.
I don't get it. The toxic half will likely go bankrupt. Why would the toxic counterparties not sue to get a claim on the muni half?
blowncue | 02.18.08 - 12:07 am | # - I have no idea what all that means but I think you just provided evidence for the case why this issue isn't going to settle cleanly or settle fast...
If we accept the idea that a pre-packaged BK acceptable to all parties is the only way this thing can be resolved quickly, the idea of the IBs getting all the equity in the muni side in return for allowing the split makes some sense. Among the parties involved -- government, IBs and shareholders -- I'd say the shareholders would be the weakest and easiest to jettison in a BK. Heck, don't corporate BKs usually do that anyway?
The best way to unscramble an egg is to have the gov't threaten you. Then pretend there wasn't an egg. Then order bacon.
"There seems to be growing unanimity of opinion among investment and risk professionals that many structured assets and associated fair value accounting rules are Acts of Satan"
Good links, blowncue.....
We are clearly in ubernerd territory here.
Feb. 18 (Bloomberg) -- Citigroup Inc., the largest U.S. bank, plans to hire ``hundreds'' of employees in Japan this year to sell investment products to affluent customers, even as it cuts jobs globally after a record loss in the latest quarter.
Psssst. Hey buddy: you all set on CDS? 'Cause this sh*t here is all insured and everything. Go on, try some.
Fred, I believe you've made my point for me. If you are a high-speed, modern Wall Street type and all you care about is modeling the risk characteristics of the transaction, then buying a bond can be considered similar to insuring a bond to the extent you are in the position of taking the loss on default. But you are insuring yourself as the bond holder, you are not insuring the issuer or other bond holders.
As a practical matter, actual insurers buy actual bonds with their reserves. They may suffer losses, but the investment managers don't promise to pay anybody else's losses, so they pretty much always have some non-zero percentage of their capital left to pay claims.
By contrast, when the insurance companies insure bonds they promise to make payments far greater than their capital on the assumption that they can predict the likely actual losses. It is a fairly extreme form of leverage. It is highly regulated because sensible people in the past thought it was a bad idea to take highly leveraged bets and call them "insurance" unless there was some way to verify that the insurers were acting reasonably and not putting the reserves into pork bellies or paying the reserves to themselves as bonuses.
I think Blowncue's excellent post is pretty consistent with what I am saying.
"tj & the bear writes:
If we accept the idea that a pre-packaged BK acceptable to all parties is the only way this thing can be resolved quickly, the idea of the IBs getting all the equity in the muni side in return for allowing the split makes some sense. Among the parties involved -- government, IBs and shareholders -- I'd say the shareholders would be the weakest and easiest to jettison in a BK. Heck, don't corporate BKs usually do that anyway?"
tj.....
We aren't at bk levels yet -- we are still technically at AAA.
However when the fate of the global financial system depends on $15 billion of capital in bizarre, archaic statutory insurance entities, we are beyond the twilight zone.
Thats what happens when you mix fas 5 and fas 133.
"Feb. 18 (Bloomberg) -- Citigroup Inc., the largest U.S. bank, plans to hire ``hundreds'' of employees in Japan this year to sell investment products to affluent customers, even as it cuts jobs globally after a record loss in the latest quarter."
No, this isn't the American stuff. It is from China. Best stuff in the world. Disregard the fine print. No that isn't English. Really, trust me, that may look like English, but it is Chinese. I wouldn't try to sell you America CDOs. This is the good stuff. It is Chinese...
Ziggurat,
I was preceding on the assumption that the only way you could legally split the "monolines" would be through the regulators forcing them into receivership. Just thinking aloud here.
Dryfly, I think there will be lots of litigation, but the regulated insurance entities will mostly be involved on a simple level - the ordinary questions such as "was the claim covered?" plus the less ordinary question of "is there any money?"
Once the New York commissioner tells them how to split up the companies, nobody is going to get very far suing them for doing what the commissioner said. They will just have to settle for suing each other (and the rating agencies).
Assuming that the CDS insureds get equity in the new muni insurance entity, if their equity stake will be large enough to offset the losses on CDSs, the current equity holders must be diluted to a very large degree; in essence wiping out the vast majority of their equity value. This is tantamount to the insureds buying the insurer, which, short term, has no value. Maybe once the markets stabilize, the muni segment become valuable enough to offset some of the CDS losses, but until then, this is just a salve for the muni market and does nothing to help the investment and commercial banks that depend on the monolines' AAA rating.
You can't make chicken salad out of chicken shit.
sk,
You out there? Got something for you.
"You can't make chicken salad out of chicken shit."
But you can call it chicken salad when you use rat meat and fool alot of people.
"Sir, I'm sorry, but the health department has closed down the restaurant for using rat meat in the chicken stir fry."
"But, I sold them the rat. Now what am I going to do?"
"Well, sir, I hear that Goldman Sachs is hiring..."
tj & the bear writes:
sk,
You out there? Got something for you.
Yup, hit me.
-K
For my money, TJ & the Bear has got this sussed out.
sk,
Had this link on my notebook faves, thought you might be interested:
Studs Terkel -- Recordings from Hard Times
dryfly:
Sorry, Keep It Simple asked whether a credit default swap was, legally speaking, an insurance policy. Which, unfortunately, is not a simple question. Short answer, no, unless an insurance company wrote it as such.
The first citation was to show that an insurance company drew a distinction between credit default swaps and financial guaranty insurance.
The second and third citations attempted to give a general and legal definition, respectively (at least in New York State) of financial guaranty insurance.
It was a technical question that I would say is only relevant insofar as who "adjudicates" disputes between parties to a cds e.g. NYS Insurance Commission vs. ? if its Joe Blow Hedge Fund who sold protection.
The new york state insurance regulator should just just shut down the monolines and put their assets and business up for auction sale so qualified buyers such as Buffett came come in and run this muni business properly.
He warned these idiots about how dangerous these overleveraged derivatives were.
Although I like Buffett immensely, let's not forget he was buying FL real estate brokerages in 2005 and he had been adding to his Wells Fargo stock at a very questionable time. His words are not always gospel.
"I have stated what the solution should be at any cost, problem is that the current participants ain't gonna like it.
risk capital | 02.17.08 - 11:27 pm"
What do you think the solution is?
Something important to remember: a screenwriter can write a poignant love story, but his director can still make it into a porn.
Looks to me like the dollar is getting set up to eat this one.
As usual there is a lot of misunderstanding here...
dryfly: "Did Ambac ever agree it would maintain a AAA rating? I doubt it." I don't have a link handy but I think the answer is 'yes they did'. "
Monolines don't guarantee ratings. All they guarantee are timely payments of interest and principal upon default. In some rare cases (like SCA), they may be penalized or required to post collateral but generally ratings have nothing to do with the business.
Keep It Simple, I'm Stupid: "Do credit default swaps legally count as insurance?"
Well, seems like simple question but I don't know the answer. I've read through a lot of Ambac and rating agency reports (I'm a shareholder) and it's never clear to me what is legally considered as 'insurance'.
What I can say is that the pay-as-you-go CDS-type contract that monolines use for structured products are constructed similar to a muni bond insurance contract and is considered a 'financial guaranty' product. But I don't know what a court of law considers as 'insurance'.
I suspect the monoline CDS-type contracts are insurance since I havent heard of anyone other than a monoline write a financial guaranty product. If they werent insurance products, everyone else would be writing the same CDS-type contracts but others (like hedge funds, banks, speculators, etc) seem to write the plain vanilla CDS contracts. Since insurance is heavily regulated, we also would have ended up with a lot more unregulated companies writing the CDS-type pay-as-you-go contracts but that never happened (all the unregulated hedge funds and others write the conventional CDS contract). So I think the monoline CDS contracts will likely be considered as insurance.
From The Jerk:
Navin R. Johnson: [bleakly] I've already given away eight pencils, two hoola dolls, and an ashtray, and I've only taken in fifteen dollars.
Frosty: Navin, you have taken in fifteen dollars and given away fifty cents worth of crap, which gives us a net profit of fourteen dollars and fifty cents.
Monolines don't guarantee ratings.
ROFL! Siv, you kill me.
samuel: ``The new york state insurance regulator should just just shut down the monolines and put their assets and business up for auction sale so qualified buyers such as Buffett came come in and run this muni business properly. `
In case it escaped your mind, there is something called property rights in USA. Itll be awefully tough for the government to shut down anyone when they have capital above the statutory requirements. Doesnt matter what Spitzer and others think. The fact that his constituents don`t want to pay a higher fee to Berkshire Hathaway Assurance, or Assured Guaranty, or others, willing to insure muni bonds is his problem.
tj & the bear writes: Monolines don't guarantee ratings. ROFL! Siv, you kill me.``
You speak like you are shocked to hear that... or is it just that you don`t understand the industry...
Does the meaning of the word "implicit" escape you, Siv?
tj & the bear
re: Stud Terkel.
That's perfect ! I rate his journalism ( in my very rudimentary way I've tried to learn by living amongst the people - "Road to Wigan Pier - George Orwell" style in 3 countries. ) - I'll listen to those interviews AND get the book I think.
And to reciprocate, the Brit aspects of this are somewhat described in the above book and its available online, along with ALL of the Orwell's works at:
The Road to Wigan Pier - Contents Page - Charles' George Orwell Links
Thanks again. Listening now.
-K
sk,
Glad to help.
BTW, note some of the interview titles:
Interview with Eileen Barthe, a relief case worker, on the humiliation to the recipients of relief.
Interview with Dorothy Bernstein, a waitress, on the shame in welfare.
Interview with Virginia Durr on shame and the fact that people blamed themselves and not the system.
Interview with Elsa Ponselle on shame and the lack of jobs.
Interview with Anna Ramsey on shame, mortgage loans, and credit.
Interview with Herman Schulmin who remembers shame and humiliation.
Interview with Tom Yoder, the son of a suburban housewife, on food shortages and the shame in poverty.
Interview with Larry van Dusen, a retired labor organizer, on the shame and depression in poverty and the rootlessness of his generation.
Interview with Ben Isaacs and Ward James on shame in taking relief and prying case workers.
Reading those you can't help but note how attitudes have changed.
p.s.: Thanks for the link!
Oops -- meant interview summaries, not titles.
re:
dotting the I's and crossing the T's
Forgot to provide link to State of New York Insurance Department Office of General Counsel's informal opinion which I quoted:
Financial Guaranty Insurance
WARNING:
I am not an attorney.
What's worse, I am a paralegal. Which really qualifies me for nothing. You might as well query the guy that changes your timing belt.
Nothing that I have ever written or will ever write should be construed as legal advice.
There is no subsitute for the lovely and talented members of the Office of General Counsel in the New York City office of the State of New York Insurance Department. The smart and sexy always ask them for an informal opinion.
This sits well with me.
In the proverbial words of Wayne and Garth...
Tort Reform: Game off, Game off!
Financial Implosion: Game on, Game on!
From the outside it seems that it makes no sense to leave the management that is part of the problem to be in charge of anything.
Downgrade them, put them out of business and let Buffett or someone else take over the muni's.
The downgrade is much more then legit, so lawsuits if any don't affect anything other then the ousted management.
Is it just me or are these monolines looking more and more like Ponzi schemes themselves?
Laws of New York
All you lawyers playing at home, click on "ISC" for insurance laws.
108 Application of business corporation law
6901(a)(1)(A)financial guaranty insurance defined
7402 Grounds for Rehabilitatio
I'm surprised we haven't heard from any biochemists yet. Since the yolk is largely lipids and the egg white is protein (albumin), I'd guess that there is a procedure of solvents and centrifuging that would separate the two, with out really being able to reassemble them. Hmmmm, and I'm guessing if the analogy holds, the solvent is lots of money and the centrifuge is lawyers and regulators,...so it's all good,...
"LaCrosse Financial Products, LLC (LaCrosse) was created in December 1999 to act as a counterparty for structured derivative products, primarily pooled credit default swaps. While MBIA does not have a direct ownership interest in LaCrosse, it is consolidated in the financial statements of the Company on the basis that substantially all risks and rewards are borne by MBIA. MBIA's guarantees of synthetic CDOs are typically executed through LaCrosse, which enters into a credit default swap with the counterparty. MBIA Insurance Corp., through a financial guarantee policy, then guarantees the obligations of LaCrosse under the credit default swap."
Is it insurance or is it a derivative? They do it in two steps. It starts out as a derivative which is then guaranteed through a policy issued by MBI insurance.
I don't think in the long run there's much difference in the holdings of the "good" bank or the "bad" bank. The bond insurers face a liability because some of the bonds won't be able to pay
then the "good" muni bonds are left uninsured. Which means the price of credit for municipalities goes up. Loss of tax revenue (because of the sub-prime mess, lack of consumer confidence, and poor investors of MBI losing their shirts) for municipalities further imperils their ratings - meaning the good banks won't be good for long.
State and municipal govt's will need to cut spending and raise taxes!! (See what Schwarzenegger is doing in CA). The federal govt. may have to step in and insure bonds - if so, the dollar goes down. What this all means to us? BUY COMODITIES!
Well, this is really uncharted territory for insurance regulation, and you can tell the regulators are making it up as you go. None of the regulators has a guidebook for this situation.
It will be interesting to see what MBI and ABK do when the market opens. I think up to half the stock price may be a bailout premium -- a hope that either IBs or the public would provide enough capital to keep them whole. That seems to be sliding away. So, there could be a big and fast drop.
Re: splitting the monolines, I was thinking back to college (almost 15 years ago now) and a class that I had where we discussed a hotel chain (Marriott, Hilton, one of the bigger chains) where the hotel split putting all the good assets into one company and all the garbage into another and issuing stock to the existing shareholders. Does anyone recall how this worked out and if there were specific laws put in place to prevent this sort of thing from happening again?
I've looked, but haven't had any luck looking for the specifics on that...
Assuming that what you are now seeing are moves of desperation in light of the recent regulator public statements and this potentially a last ditch effort to preserve equity through some market-based solution to split the companies voluntarily. In the end, in my opinion this fails. The crisis of confidence is in full force and the liklihood of restoring a frozen market with a split backed by banks, hedge funds, distressed debt investors, etc, in the interm-long run makes little sense and likely leads to the same result. In other words, you get a temporary reprieve if this is successful which I greatly doubt, but, work your way towards the same locked-up markets due to the lack of confidence which currently spreads well beyond the insurers.
That said then, the posturing that you are now seeing is likely due to the realization/private statements that downgrades are imminent, the ability to write new business has been compromised, and a regulator-based solution is likely.
If the regulators understand this, which I believe they do, then what you will ultimately see is a Buffet "or" equivalent solution where the credit quality of the endgame is not in question and confidence in the municipal aspect of the business is not in question and the market begins to function once again.
If this happens, then the stability being restored to the muni business provides time to allow for participants to replace floating rate debt with fixed lines of credit at fairly attractive rates. I think it interesting to see whether the auction rate market returns, this for two reasons; the whole concept of the potential for liquidity driven events due to borrowing short & lending long and also the current regulatory backdrop & investigations regarding bidrigging.
more on the rock-
Northern Rock shareholders may be left with nothing - MarketWatch
risk capital,
I agree with everything you wrote. Nobody can just rubber stamp the whole automatic AAA, "no loss underwriting" assumption about monolines again. This gives the ratings agency a "free pass" to go back to the drawing board and figure out what the right rating should be for each entity, and it won't automatically be AAA.
All bond issuers going forward will have to evaluate insurance for each issue on a case-by-case basis. The game has forever changed, to the detriment of the bond insurance industry.
rich-
here's to hoping the regulators put away the band-aide tin and only allow the use of surgical staples.
bac comments on litigation risk-
Bond Insurer Split May Trigger Lawsuits, Analysts Say (Update2) - Bloomberg.com
Off topic, but very interesting comment. Tim Duy via Yves Smith at Naked Capitalism:
Indeed, all the housing market doom and gloomers are missing the big story how Bernanke is actually fueling a housing boom! Trouble is, the boom is in Hong Kong. From the Wall Street Journal:
because two weeks ago and half a world away, the U.S. Federal Reserve cut interest rates again, hoping to stimulate an economy dragged down by a housing sector in disarray. Since Hong Kong pegs its dollar to the U.S. currency, it followed the Fed's lead, knocking the city's base rate down twice in less than two weeks for a total of 1.25 percentage points.
The unintended result: home-loan rates so cheap that they are throwing more fuel on an already scalding property market.
A typical mortgage here -- which is pegged to the prime rate which, in turn, is tied to the base rate -- now carries interest of about 3.1%. But compared with Hong Kong's inflation rate of about 3.8%, which is hovering at a more-than-nine-year high, that looks especially inviting, creating a so-called negative real interest rate.
Let me say up front, I know very little about this whole mess, and understand less..........
But years ago I heard a question asked of Buffett once along the lines of aren't the derivatives (CDSs) just a form of insurance. His answer "NO". He didn't explain and that was the end of the discussion.
In 2002 annual report Buffett called these derivatives (CDS) Financial Weapons of Mass Destruction. He talked about the problem of derivatives often early in the decade. He also paid good money to get rid of the derivatives book when he bought GenRE. Buffett talked about derivatives, the linkage, and how they provided systemic risk early in the decade. From what I know his predictions are coming true. He doesn't say much about derivatives anymore because I think he knows there is nothing he can do now, until this plays out. But when he offered his monoline deal he specifically didn't want the derivatives. SMART MAN, that Buffett. Way ahead of his time as usual.
Here's a little tidbit that puts the whole derivatives industry into clear perspective...let's call it the "Mortality Default Swap." This one makes me want to puke.
You can bet your life this policy will end in tears -
Business Analysis & Features, Business - The Independent
cd
I'm surprised we haven't heard from any biochemists yet. Since the yolk is largely lipids and the egg white is protein (albumin), I'd guess that there is a procedure of solvents and centrifuging that would separate the two, with out really being able to reassemble them. Hmmmm, and I'm guessing if the analogy holds, the solvent is lots of money and the centrifuge is lawyers and regulators,...so it's all good,...
I studied that stuff in chemical engineering... that's why I suggested a chicken... feed the egg to a chicken, let her digest it to produce a new egg... only way guaranteed to work. Entropy & 'irreversibility' and all.
I think that analogy applies to the monolines too... chop'em up and feed them to other entities.
Actually, I think HMBS (Human Mortality Backed Security) is more accurate.
I gotta go puke again.
cd
More financial engineering from the Masters of The Universe. This should work out great. SARCASM OFF!
My summary of this lively discussion and some questions....
1) There is no equity in the monolines anymore. There are shareholders, true, but it's clear future liabilities are LARGE, CDS related and will wash away the shareholders who are entitled to RESIDUAL value.
2) It's not going to be a normal bankruptcy because of systemic risk to the muni bond biz - so the normal courtroom rules are subject to insurance regulators.
3) It's clear there is regulatory consenus that the muni bond insurance biz is a sound "going concern" that should be preserved to prevent a systemic shock.
4) Vultures are fighting over the remaining scraps. Some of these vultures are big and have nice suits. They are not used to being pushed about by insurance regulators.
Questions I have:
Who has priority claim over the assets of the "dead man walking" monolines AFTER the municipal bond insuance policy holders ?
Are there monoline bondholders ? If yes then what are they being offered...?
If CDS is not insurance how do their claims get treated, if CDS's are pay-as-you-go why can't they monolines stop writing new CDS ?
So much for the myth of insurance.
Insurance is, by nature, shared losses. If you can't share them, it isn't insurance and why the hell would you buy it?
Feb. 18 (Bloomberg) -- Platinum rose above $2,100 an ounce for the first time...
How about applying the same principle to sub-prime mortgages directly. Split the mortgage into two parts. Assign 90% of it to a house's garage and the other 10% to the rest of the house. You can then have a "garage sale". Forgive me for the humor on such a serious issue.
Why does everyone keep assuming that the muni side is going to be safe and profitable going forward? If you strip them all out right now, put them in a pile what would happen? They'd generate no income and some of them would begin to rot. Got it? They are obligations. The "good" part is the capital upfront they had generated. The capital would have to go with the bonds. The capital is gone. That means the new "good" side of the split would also need to be recapitalized. Why would anyone do that when they could do the exact same thing but not have to take on the obligations as well? The only value in the muni side is the regulatory permission to write new muni bond insurance. How much is that worth? IMO less than nothing. I'm sure the municipalities are already casting about for alternatives to insurance given the recent massive price increases. They will go naked and take the hit with lower ratings or they will self-insure possibly. Even if there is still business to be had you can bet Buffet will get in the biz and eat your lunch.
Way up thread AllenM asks:
What do you think California debt is really worth? AAA? Really? Or CAA? The need a major tax increase...
Let's be perfectly clear here as it applies to the future safety and profitability of the muni insurance business. There is not enough money in the entire State to satisfy the appetite of California's State and municipal spending desires. The absolute very worst thing that could happen is for the State to raise taxes. My first cut for the 2008-2009 State budget looks roughly like $96b revenues $140b spending. Yes, it really is that bad and most of the budget leadership is termed out of office this year leaving the mess behind.
Now how much would you be willing to pay for bonds backed by the State of California and insured by either the existing company or the "good" half of a split company?
The absolute very worst thing that could happen is for the State to raise taxes.
Really? I disagree. The State can repeal Prop 13 as it applies to commercial property, a purpose for which it was never intended. That would significantly increase tax revenue.
Yes, it really is that bad and most of the budget leadership is termed out of office this year leaving the mess behind.
It's ironic, isn't it, that Gray Davis was "recalled" when the situation was much less dire. So when does the recall Arnold movement get underway?
number2son writes:
Dawg says: The absolute very worst thing that could happen is for the State to raise taxes.
Really? I disagree. The State can repeal Prop 13 as it applies to commercial property, a purpose for which it was never intended. That would significantly increase tax revenue.
Fixing the corporate loophole in real estate would indeed raise many billions, once. aye there's the rub, the trick is self defeating. California is already pathologically anti-business. This would be the disincentive to end all disincentives. If instead you just change it for real estate going forward it won't raise any money for a long time and is still a business burden and new business obstacle.
Regardless it would only generate a few billions of the tens of billions current spending requires.
Don't get me wrong, I too am very much in favor of closing the corporate loophole. it is just that the current economy would require that for the time being it be offset with business tax breaks in a roughly net revenue neutral process.
I actually had a lot to say about this on my blog. It affects more than just the banks, although the banks are going to get hit very hard. Bear Stearns and Morgan Stanley are going to have a hell of a time (Bear Stearns has more exposure to Ambac and MBIA than they have equity capital).
The CMBS market, hence the REITs that need to refi high LTV, low cap refi loans this year and next are going to end up all over the front page of WSJ. Ambac and MBIA have a lot more CMBS than many realize.
The homebuilders will get hit. Centex has done a lot of business with Ambac, and I see about 15% of their equity lost on bifucation of the insurer.
Then, of course, there are the reinsurers. AGO just took on $28 billion of risk from Ambac. This thinly capitalized company gets 58% of is earned premium from structured products. It will get ugly.
See Reggie Middleton says... | Reggie Middleton's Boom Bust Blog
Banks, Brokers and Bullsh1t, part 2.5? | Reggie Middleton's Boom Bust Blog for more thoughts and the links that go with them.
it would seem per the statute that if an insurance company...
(i) buys a $10M AA corporate bond issued by company X with its reserves, that's a bond
(ii)buys $10M in treasury paper and sells $10M in protection on a AA corporate bond issued by company X, that sale of protection is (as a contract) an insurance policy EVEN IF THIS WAS DONE AS AN INVESTMENT
they are mathematically indistinguishable.
that's my point.
and...
(iii) buys $10M in treasury paper and sells a knock-in at-the-money put on $10M notional spx that's NOT an insurance policy
the fact that this doesnt happen every day doesnt mean it shouldnt be thought through...
because in example (iii) if the knock-in event is the credit default of a name, even though the payout is based on spx and not loss severity, that would be an insurance policy?
my point is not whether the statue is enforceable, its whether its intelligent and of what consequence that might be.
just consider the following
if an insurer DID sell protection as an investment, replicating bond returns and maybe picking up basis arbitrage, would it wake up one day to find out it by law had entered into an insurance contract?
thats what the statute says right?
do statutes have to be interpreted to give ridiculous results?
its insurance if the underlying knock-in event is credit failure but not if its, say, some financial index crossing a certain level.
got it.
Wow, Rob, your numbers make me feel good about my $40B CA deficit SWAG a few days back!
I don't know that too many are still arguing that the muni bonds are all that safe, just that the government's actions are totally motivated by self-interest.
p.s.: Futures up pretty good, so obviously there's nothing to worry about.
btw if im not mistaken cboe has exchange-traded cds contracts.
so anyone BUT an insurance company shorts one of those, that's an investment, but if an insurance company did it, that's an insurance policy?
i suppose the beneficiary is the exchange?
interesting concept.
if your answer is, of course not, that's an investment, says who?
because it was "intended" as an investment?
the statue doesn't incorporate "intent" as a component of the definition.
hmmm....
Oh, man, do I have some stories about 'bandos'.
I think this topic deserves a post of its own, even if the MSM has scooped us.
This is just a subtle form of Chapter 11. Defaulting on the bad and retaining the good.
Fred, we are talking past each other. Part of my point is that the insurance company can't enter into mind-stretching transactions just because a quant says they are mathematically the same as investing in AAA bonds.
The other part of my point is that buyers of regulated insurance contracts have the regulators to fall back on when the insurance company does something stupid.
You can think about modelling equivalent transactions all you want. You'll probably have about twenty years to think about it before anybody is interested in buying any of those products again.
When we talk about muni bonds as being "the government" and how this deal is about preserving "the government's" ability to raise funds, let's remember who and what we are talking about here. I just got my property tax statement for 2008 and a big chunk of it will go to pay off bonds. No monorails; just voter-approved levies for new school and parks, backed by property tax revenue. If insurance regulators can help to work out a deal that keeps interest rates as low as possible for my city and my school district, that is okay with me. Personally, I don't want to see local goverments and local taxpayers suffer any more than necessary from the mistakes made by investment bankers and monoline insurance executives.
"...just that the government's actions are totally motivated by self-interest.
Exactly. The Titanic is going down and they want their kin - munis - in a lifeboat. (The quality of the lifeboats is a whole new question).
tj & the bear writes:
Wow, Rob, your numbers make me feel good about my $40B CA deficit SWAG a few days back!
Well if another $1200 of debt for every man, woman and child in the State makes you happy...
Quick breakdown. CA expects $109b revenue, Dawg predicts $96b. CA expects to roll over $10.5b existing unresolved deficit, Dawg predicts $7.5b. CA plans on robbing trust funds particularly transportation $4b(?), Dawg $1.5b tops due to legal challenges. CA wants to "save" $2b in Medi-Cal by cutting payments to doctors just because they think they can. Dawg thinks net will be +$2b in unintended consequences healthcare costs. CA plans on issuing previously approved GO bonds and maxing out several special use bonds to unused limits $13b. Dawg thinks price and terms and incompetence will get at most $11b. That's just the bad revenue assumptions. Don't even get me started on the spending side. They are already running a billion a month above trend and the underemployment consequences have not yet hit.
I don't know that too many are still arguing that the muni bonds are all that safe, just that the government's actions are totally motivated by self-interest.
Self-interest yes but all the proposals seem to assume the muni side is adequately capitalized. I don't see it.
"btw if im not mistaken cboe has exchange-traded cds contracts."
They actually trade credit event binary options - all or nothing payout ($100,000 per contract) based on whether the reference security has a credit event.
"i suppose the beneficiary is the exchange?"
The exchange makes money on transaction fees levied. Not sure who they have as market makers for these - Citadel, Timberhill, Susquehanna, Goldman?? dunno but that's who would be the other side of most of these trades and subsequently stand to make or lose money from trading with you.
Of the few they have listed the ones on Hovnanian seem the most interesting. The Sept 2008 expiration is
$20.50 bid by $24.50 offer
and the Sept 2010 expiration is
$78.00 bid by $86.00 offered.
These contracts have a 1,000 mulitplier so if you thought Hovnanian is going to have a credit event prior to Sept 2010 you could pay $86,000 for a contract that pays $100,000 if the default occurs. The market is basically saying default by Hovnanian is all but a certainty as this point.
FYI the reference obligation for Hovnanian is a bond with a 6 1/2% coupon with a maturity of 1/15/2014. I'd love to know what that bond is trading at...If the options are any indication those bonds should be trading at a steep discount to par...
John Stark says; Personally, I don't want to see local goverments and local taxpayers suffer any more than necessary from the mistakes made by investment bankers and monoline insurance executives.
Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt.
Westland/Hallmark Recalls Record Amount of U.S. Beef (Update4)
Maybe a recall will work on CDO/CDS too... just replace 'ground beef' with 'ground up mortgages'...
"Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt."
And that gets my vote for best post of the day...
They are going to suffer mainly because they no longer have an artificial prop that will magically turn mid-tier debt into AAA for a cheap price. They will have to pay market interest rates to borrow money, like most companies do. Or, they will have to undergo more credit scrutiny and pay higher premiums to obtain strong bond insurance.
What's wrong with that?
Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt.
There is the general public too Bob, these folks do provide services like water, sewer, police, fire... etc.
Even with things like water & sewer the period cost is covered by fees but capital cost is bonded.
And not everywhere gold plates services & salaries like California. In my world when bureaucrats make dumb decisions it effects both ends of the pipeline - tax payers & service consumers both get screwed (which in theory is really the same - taxpayer consumer of service - but few look at it that way).
It won't just be tax payers who suffer when this blows up.
This whole "crisis" has the air of bogosity (bogusness? bogositude?). Why are investors and fund managers depending on "ratings agencies" and "insurance" bought by the issuer of the scurities? Sort of like a movie studio hiring a review of their latest blockbuster.
As an investor, especially a supposedly sophisticated one, you are supposed to do due diligence and believe in what you invest in and take your lumps like a grown-up if you are wrong. It's no different from listening to stock analysts, who say "sell" at $3 and then change to "buy" at $15. This so-called "insurance" was phony from day 1.
The life insurance sale thing is beyond disgusting.
At least when the Romans threw the Christians (and criminals and gladiators, with weapons) to the lions everyone knew what was going on.
Will Bear Stearns then contract with the Maf to kill people off if they live too long?
Local governments cannot "suffer." They have no hearts to break nor hands to hold. Taxpayers are the ultimate bagholders of poor municipal decisions including ill conceived debt.
The point I was trying to make was that the government is, ultimately, us. I do have a hand to hold and I will suffer if my local governments have to pay more to build schools and buy parkland. Not all public debt is "ill-conceived," and on my tax bill, most of that bonded debt was created by vote of a 60 percent supermajority of the electorate.
If the monoline insurance was bogus from the beginning, good riddance to it. Without it, my local governments are going to be paying just a few more basis points on bond issues, using money provided by me. Not a catastrophe. My city, for example, should still be able to get bond ratings above investment grade without insurance; they often chose to issue bonds without the insurance in the past, because the premium cost sometimes did not justify the interest rate savings.
If you support police union, teacher union, prison guard union, and state employee union, please the due in form of union due and higher tax. Period. Don't blame wall street on your crazy spending. You get what you support.
re "ill-concieved debt":
A world in which some small municipality issuing securities in 2004 had to understand the risk of market collapse created by the highly complex and almost completely undocumented shadow banking system is not one in which humans can live. The credit system must be regulated to the point that normal people - without PhD's in economics or years of experience in structured finance - are able to make reasonable decisions about credit amongst the options available to them. Insofar as we can, we need to make good the mess created by failing to meet this standard in the past, and if this troubles some Cayman Islands hedge fund that bought CDS insurance from FGIC well, tough, the owners will survive.
Bundle up the "bad" part, spin it off as a new company called "Adventura", and offer it at $10 per share with a coupon for a 2 pound bag of Starbucks coffee.
California is one of the very few states that can borrow to cover operating deficits. The rest have to balance annual revenue and expenses. Thank goodness and good luck to sunny cal!
The flood of information is starting to be so much that average newspaper readers probably need to see novel headlines to even read another article about mortgages.
Consider this big news, which is buried in an article:
"According to the Mortgage Bankers Association, the delinquency and foreclosure rate for all mortgages is 7.3 percent, higher than at any time since the group started tracking that data in 1979."
No Lull in Mortgage Pitches - NY Times
The gap between those who pay attention and the popular idea: Bernanke says bottom in late 2008 (!!??)....is large.
This so-called "insurance" was phony from day 1.
No it wasn't - it played a vital role within the context it was originally used - to spread risk over many smaller municipal offerings where no single one was large enough to warrant 'sophisticated investor' attention & resultant DD but in aggregate are sizable and to those residents important.
So you have a 1000 small municipalities offering up individual bonds... One in a 100 might go bad... but which ones? The insurers were supposed to do the DD and for a premium insure the lot... the investors then were 'sure' they'd get a safe investment and not have to tease through all these individual issuances.
Assuming the insurer did DD & used sound actuarial practices every thing was fine... and in the case of munis historically they have been fine. The system broke down with this CDO, CDS crap. The insurers didn't do the DD and they didn't practice sound actuarial methods (cause they didn't understand what they were insuring - they never should have gone there).
So now we are trying to tease the two apart and it isn't pretty.
Hopefully the industry will fall back on its 'roots'... small town & county issuance and stay the hell away from CDO/CDS... that is where Buffet will be soon & probably make a killing too.
Nobody is having fun with what the two entities could be named:
Crimson Permanent Assurance and
Cerulan Everlasting Solemnity
Damn, the first one is already taken.
Drayfly,
The default rate is more like 1 on 210 and even then it isn't a 100% loss. The historical losses were so miniscule I never understood the need for insurance in the first place. How many people carry meteor insurance riders? I can see the value of aggregation as you describe it but I fail to see how such a small risk exposure was financially engineered into such a large problem. Being a real engineer I think I see the problem; derivatives. First derivative = velocity, second = acceleration. There is a third derivative as Dryfly is well aware even though it isn't used very often. I've used it when analyzing thinks like piston motion and composite structures. For all those would be financial engineers out there cooking up third derivative products take heed of the name; jerk.
"Assuming the insurer did DD & used sound actuarial practices every thing was fine... and in the case of munis historically they have been fine."
dryfly- The munis were fine not because of the insurers, but because the munis inherently were and are fine (because of the dependable revenue stream). Muni bonds existed for centuries before anyone dreamed of insurance.
As far as the 1/100 going bad, in reality it's MUCH lower than that. And you can address it by putting together a diversified portfolio, just as well as with "insurance".
Entrusting your money to others may give some people a sense of security, but often times it is a false one.
But the whole story is that municipal bond insurance enabled a lot of excessive borrowing by marginal municipal authorities, well above prudent borrowing limits and for specific projects that lack the economics to repay their debts.
That's the next chapter in the story. So, wait for the whole story before you write the ending.
The Big Question is ultimately whether Bernanke, Paulson and Congress along with NAR can manage to somehow hold back the waters....
If they hold back the waters, then municipal bonds are OK. If not, it's a more complex story.
Can house prices be propped up? Only by increasing demand somehow. The easiest way to increase demand is somehow get house prices down enough and also the economy stabalized.
Isn't that an impossible combination? Perhaps there is a way.
Let prices decline some more, and then transfer all the mortgages possible (after writedowns) to FHA so the taxpayer absorbs further losses. This is probably the plan that will be most advocated.
Of course, in order to accept for instance 80 cents on the dollar for your underlying loan takes a great deal of awareness and toughness and planning for the securities holders, and how could that happen? So a unfolding royal mess looks more likely until finally they rush desperately to just that plan. Then you and I can hold the bag for any further declines thru tax liabilities.
...
mike-
on hov, last trade at 70 on 2-14
Hi Guys,
I just wanted to thank everyone for helping me learn more about what's going on. Yes, we all love what CR and Tanta write and we learn from them. But we also learn from reading YOUR comments.
Thank you!
For all those would be financial engineers out there cooking up third derivative products take heed of the name; jerk.
Rob Dawg | Homepage | 02.18.08 - 12:07 pm | #
Rob - the only value was in the aggregation of risk for small issuers. Hell even NYC or Cook Cty Illinois or Orange Cty Cali are big enough they shouldn't need 'insurance'... people know where they are and can do the DD as AOTC suggested.
But what about Brown County Minnesota? If they want to put in rural water 'cause the ground water is bad who's gonna do the DD to buy those bonds?
Turns out I know a little about Brown Cty 'cause I drive through it all the time... reported average incomes are pretty low and would look like a bad bet on paper... except a whole lot of them are farmers who are land rich and cash poor with 2000 acre spreads most of which are owned nearly debt free... land out there is going for $4000 an acre. I'd bet on them paying the bonds back before I'd bet on Orange or Cook Cty!!
But you'd have to know and who has time to drive and ask questions in every rural county & muni?
So pay AMBAC a premium to do it for them and give them a rubber stamp and then you and I don't have to drive Brown Cty & do a head count of asset collateral.
Investor gets a nice safe return & Brown Cty gets rural water & AMBAC collects a premium - win, win, win.
That was what those things were originally for and those jerks blew it all up.
risk capital writes:
on hov, last trade at 70 on 2-14
That's only 9.3%. Hardly seems like much of a risk premium. What am I missing?
dryfly- If I were invesiting in Minnesota bonds, I would rather put together a portfolio of Brown County, a few other rural conuties, some Twin Cities suburbs, some St Paul, some Vikings Stadium, etc. I'd feel better about that than a "guarantee' from an opaque entity that I know nothing about.
rob dawg-
calculate ytm, you might feel differently.
But the whole story is that municipal bond insurance enabled a lot of excessive borrowing by marginal municipal authorities, well above prudent borrowing limits and for specific projects that lack the economics to repay their debts.
My experience is you will be wrong IN AGGREGATE. Some did but not enough muni losses to take down the whole system.
I mean property insurers made some bad bets insuring east cost coastal property too... and hillsides in Cali, etc.
But in aggregate property insurers mostly survive their losses, learn & rejigger the actuarial tables & do better DD next time.
Likewise with the monolines.
Going forward they will need to learn & charge some of the dicier munis more for a solid rating... or pass on them like property insurers do with brush country in Cali or beach property on the east coast.
Point is the muni bets they made weren't always smart but they weren't fatal. CDS bets they made are fatal.
It's quiet out there - too quiet...
CR seems to be on vacation. Well I'm sure there will be more dismal news Tuesday for us to dissect.
Dry,
We are turning into a mutual admiration society. Exactly, aggregation for the small and Due dilly for the large. You may not like the looks of Cook Cty or The OC but my evil eye is on the PANYNJ. Those idjits seem to have been drinking the Wall Street brand Kool-Aid made with Hudson River water. 60% increases on the Geo Wash Bridge? [Side note; people don't know it generally but bridge tolls are considered transit fare revenue so when you hear that NYC transit users pay half their operating costs don't believe it.]
The more i think about it the more i dislike the idea of insuring munis. It increases costs and clouds transparency and induces poor financial behavior on the part of both parties.
PIK bonds - impossible to default?
kinda like CDS/CDO , being collateralized on a daily basis, so says the occ , in there quarterly report.
Maybe CR will have an attitude adjustment and decide to post 50:50 good:bad news.
I'd feel better about that than a "guarantee' from an opaque entity that I know nothing about.
The opaque entity needed to be less 'opaque'... they were at one time before the CDS crap clouded it all up. Muni insurance was pretty straight forward and easy to understand.
And as for Brown Cty... why insurance if they are so rock solid? Because the bonds go for thirty years and if you had a way back machine you'd remember Brown Cty wasn't so rock solid in the Farm Crisis (20 years ago). Who said it can't happen again?
Shit happens - that's why even responsible people have insurance. Insurance aggegates & smooths risk but it has to be well founded in actuarial practice & DD. Worked for munis for a long time - not for CDS.
Maybe CR will have an attitude adjustment and decide to post 50:50 good:bad news.
Define 'good' define 'bad'... News is news read it & make your own judgment.
Dawg-The bridge tolls were not about revenue (at least that was the story). They were supposedly hiked to discourage vehicle from coming into Manhattan. I don't think that worked, but that was supposedly the reason.
dryfly-"Define 'good' define 'bad'... News is news read it & make your own judgment."
Quite true, but only one story can be the banner headline.
dryfly,
exactly - why insist on oversampling to confirm observation bias - CR is even handed and if he seems to be 'pushing' negative views a lens tint check might be in order...
AOTC- Not unlike people complaining about the MSM focusing on the bad. Well, that's what sells newspapers. Happy news in the face of problems gets you labeled "fluffy".
the larger point is what grounds exist for a takeover or similar simply to preserve a AAA rating of the insurance company.
i concur if the aggregate claims paying ability falls too low its fair game and i can reasonably concur that some kind of waterfall or liability based restructuring would be licit.
i also recall that in ny state insurers are not fiduciaries of their insureds.
but...
if its not a matter of severely impaired claims paying ability but to preserve a AAA rating so the muni issuers can enhance more cheaply than by paying market rates...
i just dont see it.
suppose i have key man life insurance. and i have partners as beneficiaries.
i agree that a serious threat to claims paying ability is ground for regulatory action but...
is my desire as an insured to be able to say to prospective clients, "hey, at our firm, our lawyers are covered by life insurance from a AAA insurer, so if anyone dies theres money to bring a replacement up to speed; now those guys over there, their insurer is only rated A..."
is THAT reason for regulatory action?
did the insurance policies the muni issuers bought guarantee the payment of principal and interest should they fail to do so or did they also guarantee that AAA credit enhancement would be a consequence of the policy?
somehow i doubt the latter.
so why would an imminent ratings drop to, say, A+ or A from AAA be ground for takeover?
of course, if it's a well-known "secret" that the real rating of these monolines is more like CCC, sure...
but then that's just one more reason to hold the ratings agencies in contempt...
but that would be off topic
still though am i off to say that a takeover based on impaired claims paying ability while the ratings agencies insist mbia is better capitalized than fgic is implicitly saying the ratings agencies are full of s--t?
fred
eagan-jones has mbia at B+, s&p and moody's at AAA
who's full of shit?
make that ega
dryfly-Where I see the disconnect with reality is the Port Authority paying 4.5% with insurance and then jumping to 20% because the bond insurers are in trouble. Even if the insurance came from God Almighty him/herself it doesn't justify a differential like that.
Amen Fred - I just can't see it either - especially can't see the justification in wiping out the equity of what is at worst an A rated Company. I think if these were Financial Guaranty Contracts, they merely guarantee the payment of P&I as and when due. Not CDS requiring posting of collateral in a downgrade (which is what sent Enron into BK on its commodity swaps). So if the CDO assets are transferred into a new subsidiary, even if rated A or BBB, so long as the insurance commish signs off, how can the banks complain. They are less sure that they will be paid? That is a long way from insolvency.
Aheadofthecurve writes:
Where I see the disconnect with reality is the Port Authority paying 4.5% with insurance and then jumping to 20% because the bond insurers are in trouble. Even if the insurance came from God Almighty him/herself it doesn't justify a differential like that.
The differential is fully justified by an open outcry market pricing of the instrument. They want to bump Motorcycle fares 66% and 75% to cover debt. As noted above they don't call it covering debt but it still quacks like a duck. That smells of desperation and the markets confirm.
They also have an interesting Constitutional test to face. They are attempting to charge more for cash than for their own scrip (E-ZPass).
Rob-Where's the Constitutional issue with the EZ pass? It's a discount for frequent users and they save on toll collectors salary. Ameritrade charges less to buy and sell on-line than by phone, because it lowers their costs. How is that illegal?
AOTC,
Read the part about "all debts public and private." You can offer a cash discount but you cannot apply a cash surcharge.
Rob Dawg - Constitutional test? Nothing of the sort. Half the arcades I went to as a kid had tokens that conferred some advantage over quarters. Oh, and FastPass on the tollroads here in orange county offers a discount for using their transceivers over using cash. Has for years.
Bear Sterns and Everquest anyone???
We all remember how that panned out. I'm sure this is sufficently different enough to work out though.
Rob-Have you ever tried to rent a car with cash?
Why in the world would the fact that something is happening have anything to do with it being Constitutional? Jeez, get with the new century people. What PANYNJ is doing is valuing its scrip more than the face value. Not legal. there are ways around this but they apparently cannot be bothered by playing by the rules. IANAL and I don't play one on the internets but this I know.
No, I never have tried to rent a car without a ccard. What does that have to do with the rental price? You pay more for cash? no, you are talking about something else in the contract.
Well, as we say in New York, "So sue me".
Dawg: Why in the world would the fact that something is happening have anything to do with it being Constitutional? Jeez, get with the new century people.
Aheadofthecurve: Well, as we say in New York, "So sue me".
Exactly. The nice trooper with the big gun explains in the nicest terms that you either pay $4 in PANYNJ scrip or you pay $7 with some dirty Federale lucre or you go to jail where the cash and credit prices are by law the same. Where's Groucho Marx when you need him?
Rob-I'm sure you've heard of the tax protesters who walk into their local IRS and try to pay their taxes in pennies (legal tender). They get escorted out by security, these days probably to Gitmo. Don't try this at home.
riskcapital,
Thanks. Where do you go for bond quotes??
YTM on those (HOV 6.5 of 2014)is close to 14% right??
Auction-Rate Bonds Lure Investors With 20% Interest (Update1) - Bloomberg.com
Forget about getting rich on failed auctions.
Hedge funds to the rescue.
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'Auction-Rate' Freeze Thaws a Little
High-Altitude Yields
On Safe Issuers' Debt
Lure Bargain Hunters
By GREGORY ZUCKERMAN and KAREN RICHARDSON
February 16, 2008; Page B1
One crisis-plagued corner of the credit markets shows glimmers of healing a little.
As more conservative investors shun "auction-rate" securities -- debt from municipalities and other issuers with rates that reset on a frequent basis -- some hedge funds and other sophisticated investors are nibbling, seeking bargains and opportunities amid the market's difficulties.
Ziggurat,
Guess it goes to show that greater transparency leads to more efficient markets. The media reported the horror of PANYNJ having to pay a 20% rate due to a failed auction - people who knew nothing about the auctions will now likely participate in the next - yields should drop.
sorry about that .... failed cut and paste
'Auction-Rate' Freeze Thaws a Little - WSJ.com
AOTC,
I hear ya. Any tinfoil I wear is because of the aliens not the gubmint.
Pennies aren't legal tender above a certain amount and the way things are going even the zinc is likely to be worth more than face soon enough.
We get all kinds of down deep in the guts here at CR. My point really is a simple one. You cannot create your own currency. 4 E-ZPass dollars cannot equal 7 US dollars at the toll booth when you can also buy 4 E-Zpass dollars for 4 US dollars.
There is a larger Interstate issue as well. Clearly charging more for occasional users is both a commerce and equal protection issue.
Freakin' A the E-ZPass system offers discounts to Nets home games. Tell me this isn't discriminatory.
Like I said before there are remedies. One would be to eschew Federal assistance. Another would be tokens. PANYNJ isn't inclined.
Rob-When I go to NYC, which I only do about once a year, I take the Taconic Parkway to the Saw Mill River and then pick up the Cross-Bronx to the Henry Hudson. I pay no tolls that way and it's much prettier.
Aheadofthecurve writes:
Rob-When I go to NYC, which I only do about once a year, I take the Taconic Parkway to the Saw Mill River and then pick up the Cross-Bronx to the Henry Hudson. I pay no tolls that way and it's much prettier.
That was you? Must confess, I only do this every 2nd or 3rd year these days. The Taconic State Parkway and the Mass Pike thereon connected are artworks worthy of preservation. I still remember my dad driving to Florida in the mid 60s cursing the GW Bridge toll.
My point really is a simple one. You cannot create your own currency. 4 E-ZPass dollars cannot equal 7 US dollars at the toll booth when you can also buy 4 E-Zpass dollars for 4 US dollars.
Except you can. Arcades do it. Casinos do it. Airlines do it (frequent flyer miles). Gift cards. And many toll systems, including the one I use, already do what NY is doing. IANAL, but I guarantee you the courts have already looked at this and said "no problem". I suspect that the crux is that tokens/credits/certificates that can only be exchanged for a limited suite of items don't count as "currency". The point of currency is that you can buy virtually anything with it.
Fair Economist,
You are supporting my point. Gift cards have 1;1 or better dollar values. Same for casinos. Just try and exchange 4 "gambling bucks" for $7 US tender like PANYNJ is doing. You cannot because it is illegal. tokens and such are the acceptable cheat. Make no mistake I understand the workarounds and wouldn't bother fighting them. PANYNJ cannot be bothered with such and has instead gone ahead and created their own currency with asymmetric exchange rates to the US dollar.
mike-
yes, 14+.
use this service-
FINRA - Investor Information - Market Data
upper right, use the drop-down menu to search by issuer, indicate "bond", will pull all of the outstanding issues, provide time, sales, and trade data.
or bloomberg by subscription.
By the way, they take Canadian money on the NY Thruway and many stores around here (Albany). Is that illegal?
headofthecurve writes:
By the way, they take Canadian money on the NY Thruway and many stores around here (Albany). Is that illegal?
Illegal no, unauthorized, yes. The PANYNJ says it accepts up t $100 US but US only. This is a loophole for some agencies you can freely exploit if you wish.
risk capital,
Thanks for the link. I can haz blumburg at wurk not in mi casa...
From Wikipedia,
A fraudulent conveyance, also fraudulent transfer is a civil cause of action. It arises in debtor/creditor relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy trustees. The usual fact situation involves a debtor who donates his assets, usually to an "insider", and leaves himself nothing to pay his creditors as part of an asset protection scheme. However, it is not uncommon to see fraudulent conveyance applications in relation to bona fides transfers, where the bankrupt has simply been more generous than they should have or, in business transactions, the business should have ceased trading earlier to avoid giving certain business creditors an unfair preference (see generally, wrongful trading). If prosecuted successfully, the plaintiff is entitled to recover the property transferred or its value from the transferee who has received a gift of the debtor's assests.
There is an old equitable maxim: "One must be just, before one is generous."
[edit] Fraudulent conveyances or transfers in the United States
In the United States, fraudulent conveyances or transfers[1] are governed by two sets of laws that are generally consistent. The first is the Uniform Fraudulent Transfer Act[2] ("UFTA") that has been adopted by all but a handful of the states.[3] The second is found in the federal Bankruptcy Code. [4]
There are two kinds of fraudulent transfer. The archetypical example is the intentional fraudulent transfer. This is a transfer of property made by a debtor with intent to defraud, hinder, or delay his or her creditors.[5] The second is a constructive fraudulent transfer. Generally, this occurs when a debtor transfers property without receiving "reasonably equivalent value" in exchange for the transfer if the debtor is insolvent[6] at the time of the transfer or becomes insolvent or is left with unreasonably small capital to continue in business as a result of the transfer.[7] Unlike the intentional fraudulent transfer, no intention to defraud is necessary.
The Bankruptcy Code authorizes a bankruptcy trustee to recover the property transferred fraudulently[8] for the benefit of all of the creditors of the debtor[9] if the transfer took place within the relevant time frame.[10] The transfer may also be recovered by a bankruptcy trustee under the UFTA too, if the state in which the transfer took place has adopted it and the transfer took place within its relevant time period.[11] Creditors may also pursue remedies under the UFTA without the necessity of a bankruptcy.[12]
Because this second type of transfer does not necessarily involve any actual wrongdoing, it is a common trap into which honest, but unwary debtors fall when filing a bankruptcy petition without an attorney. Particularly devastating and not uncommon is the situation in which an adult child takes title to the parents' home as a self-help probate measure (in order to avoid any confusion about who owns the home when the parents die and to avoid losing the home to a perceived threat from the state). Later, when the parents file a bankruptcy petition without recognizing the problem, they are unable to exempt the home from administration by the trustee. Unless they are able to pay the trustee an amount equal to the greater of the equity in the home or the sum of their debts (either directly to the Chapter 7 trustee or in payments to a Chapter 13 trustee,) the trustee will sell their home to pay the creditors. Ironically, in many cases, the parents would have been able to exempt the home and carry it safely through a bankruptcy if they had retained title or had recovered title before filing.
Even good faith purchasers of property who are the recipients of fraudulent transfers are only partially protected by the law in the U.S. Under the Bankruptcy Code, they get to keep the transfer to the extent of the value they gave for it, which means that they may lose much of the benefit of their bargain even though they have no knowledge that the transfer to them is fraudulent.[13]
Some of the most egregious fraudulent transfers occur in connection with leveraged buy outs, where the management/owners of a failing corporation will cause the corporation to borrow on its assets and use the loan proceeds to purchase the management/owner's stock at highly inflated prices. The creditors of the corporation will then often have little or no unencumbered assets left upon which to collect their debts. LBO's can be either intentional or constructive fraudulent transfers, or both, depending on how obviously the corporation is financially impaired when the transaction is completed.
Although not all leveraged buy outs ("LBO's") are fraudulent transfers, a red flag is raised when, after an LBO, the company then cannot pay its creditors.[14]
[edit] Footnotes
^ The term fraudulent conveyance is included within the more general term fraudulent transfer, as a conveyance is more descriptive of the transfer of title to real property. Fraudulent transfer, however, includes all types of property and in the U.S., both are generally all governed by the same law. Therefore, the transfer will be used for the remainder of this section.
^ Promulgated by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1984
^ As of June, 2005, 43 states and the District of Columbia had adopted it. See NCCUSL website, NCCUSL Home. A complete copy can be found there or at http://www.stcl.edu/rosin/ufta84.pdf
^ 11 USC § 548. Much of the language of this section was adopted from the Uniform Fraudulent Conveyance Act, which is the predecessor of the UFTA.
^ 11 USC § 548(1); UFTA § 4(a)(1).
^ Under the Bankruptcy Code, insolvency exists when the sum of the debtor's debts exceeds the fair value of the debtor's property, with some exceptions. It is a balance sheet test. 11 USC § 101(32)
^ 11 USC § 548(2); UFTA § 4(a)(2).
^ This is done through the mechanism of avoidance of the transfer. 11 USC § 548.
^ 11 USC § 551
^ Within two years prior to the filing of bankruptcy - 11 USC § 548(a)
^ 11 USC § 544(b) allows trustees to employ applicable state law to recover fraudulent transfers. The time period under the UFTA is in most cases four years before action is brought to recover. - UFTA § 9.
^ UFTA § 7.
^ See, Gill v. Maddalena, 176 B.R. 551, 555, 558 (Bankr.C.D.Cal. 1994) (citing 11 USC § 548(c))
^ See, for example, Murphy v. Meritor Savings Bank, 126 B.R. 370, 393, 413 (Bankr. D. Mass. 1991), in which an LBO left the corporation with insufficient cash to operate for longer than 10 days.