Sunday, 22 February 2009 23:00

Is MBIA About to Pull the Wool Over the Market's Eyes?

I would like to make it clear that MBIA and the other
monolines have assisted the investment, commercial and mortgage banking
industry in the significant inflating of the perception of capital available.
If (or more aptly, when) this charade comes to an end (apparently
imminently) the banking system will recieve another, quite significant
shock to the system. One of several very interesting emails that I
received over the weekend.


I am e-mailing about MBIA's recent restructuring announcement, which
involves the transfer of $5B out of MBIA Insurance Corporation to one
of its subsidiaries, MBIA Illinois (to be renamed). $2.9B of the $5B
was paid for MBIA Illinois to reinsure 100% of MBIA Insurance
Corporation's public finance exposures. The remaining $2.1B was
transferred via a return of capital to MBIA Inc., MBIA Insurance
Corporation's parent. Concurrent with the transfer, MBIA Insurance
Corporation's ownership interest in MBIA Illinois has been confiscated
and transferred to another MBIA subsidiary. On the surface, this
wreaks of blatant theft and fraud.

Based on a detailed review of servicer reports of the majority (several hundred) of RMBS securities bundled into MBIA's CDOs, I believe that this restructuring leaves MBIA Insurance Corporation insolvent by billions of dollars. This

Required reading for this article includes:

  1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton.
  2. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap
  3. Follow up to the Ambac Analysis
  4. Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibility
  5. Bill Ackman of Pershing Square - How to save the Monolines

For those interested in the history, see Insurers and Insurance in m blog. There are literally 100's of pages of opinion and analysis over the last 9 months.

The dominoes should start to fall...

If any body believes I have an inkling of knowing my way around these
investment markets, I strongly suggest you re-read my Asset Securitization Crisis series, in particular, "Counterparty risk analyses - counter-party failure will open up another Pandora's box"
(must read for anyone who is not a CDS specialist). We wil be entering
into the next phase of the crisis, for I believe that the CDS market
will start showing fissures that will illuminate rampant counterparty
credit risks through the global capital markets. These insurers used
CDS almost exclusively for their structured product wraps and insuranc

is based on optimistic RMBS loss assumptions - mortgage defaults reduce dramatically overnight, almost all 30-89 day delinquencies immediately cure, loan loss severities improve when compared to recent experience. It also assumes no losses from other exposures (e.g., commercial real estate, corporate debt, manufactured housing, auto loans, etc.). Using more assumptions more consistent with market pricing for RMBS and other exposures (e.g., CMBS), the restructuring could leave MBIA Insurance Corp. insolvent by over $10 billion.

The only explanation I can imagine that might arguably justify the restructuring would be the termination of the majority of MBIA's problem exposures at a steep discount. Even this would not truly justify raiding MBIA Insurance Corporation's capital, but it would make it less of a blatant fraud. If there is some explanation that justifies this restructuring, then someone should explain, as this will increase confidence in MBIA's new operation. If there is no valid explanation, then it means that MBIA is in the process of perpetrating a large-scale theft, with the blessing and assistance of New York Insurance Commissioner Eric Dinallo.

I am fearful of speaking out publicly because I work in the insurance industry. At the same time, it would be disgusting if MBIA were allowed to get away with what appears on the surface to be a massive fraud. I am not sure about how to best ascertain whether this restructuring is as bad as it appears, but I have drafted the attached letter as a public appeal for someone to explain.

Unless there is an innocent explanation, the situation deserves a thorough investigation by various authorities, possibly including attorneys general in NY and IL, the SEC, and the National Association of Insurance Commissioners. I think very highly of what you have to say, so I would be greatly appreciative to hear your thoughts.


st1:*{behavior:url(#ieooui) }

Appeal to MBIA Management, Stakeholders, and Supporters

As MBIA management and major stakeholders are well aware, short-sellers of MBIA shares (notably Pershing Square and T2 Capital) have released public analyses that project large losses on MBIA Insurance Corporation's structured finance exposures. Recent market prices for residential mortgage-backed securities and RMBS pool statistics suggest that losses might exceed short-sellers' figures. These estimates suggest that the transfer of assets from MBIA Insurance Corp. leaves the company insolvent by a significant margin. In other words, MBIA's recent restructuring announcement reveals a massive scheme to confiscate assets from other MBIA Insurance Corp. policyholders for the benefit of MBIA management and holders of MBIA insured municipal debt.

If MBIA Insurance Corp. is at risk of insolvency, regulators are justified in ensuring a fair allocation of financial resources for public finance exposures. However, if this is necessary, superior protection to insured municipal bondholders by placing MBIA Insurance Corp. under regulatory supervision, without confiscating the residual interests from other stakeholders.

If the restructuring leaves MBIA Insurance Corp. well-capitalized to withstand additional stress beyond short-sellers' loss projections, then it would be very beneficial for stakeholders and the public to clearly understand this. For example, if MBIA terminated the majority of its riskiest exposures at a steep discount to expected losses, this would suggest an improvement in MBIA's financial condition.

The doubt about MBIA's solvency hurts stakeholders by reducing the value of MBIA's common shares, debt, and surplus notes, and severely diminishing the market value of credit enhancement provided by MBIA. Therefore, even if MBIA Insurance Corp. can withstand critics' most pessimistic estimates, MBIA stakeholders would benefit greatly from a public analysis that supports MBIA's reported losses. This letter appeals to MBIA management, stakeholders, and other supporters to provide such an analysis. Such a presentation would be especially persuasive by focusing on two key problem areas: (1) collateralized debt obligations (CDOs) with significant RMBS exposure, and second lien securitizations (home-equity lines of credit and closed end second liens).

When it comes to CDOs, stakeholders would benefit immensely form an examination of one or two representative mortgage-backed securities bundled into one of MBIA's riskiest CDOs, and an estimate of overall losses implied by repeating this analysis for other securities included in the CDO. Stakeholders would also benefit from an understanding of key factors that mitigate losses, including future premium installments, reinsurance, and expected settlements or early terminations.

For second lien exposure, the public would benefit greatly from an examination of one or two of MBIA's riskiest second lien deals, including key assumptions (e.g., roll rates, future delinquencies, prepayment rates) and resulting losses. As with CDOs, it would be extremely valuable for the public to understand factors that mitigate MBIA's losses, like future premium installments, timing of payments, reinsurance, settlements, and expected litigation recoveries.

Aside from MBIA management, a few potential candidates to provide this type of evaluation include Tom Brown, who in 2008 provided a string of analyses of subprime losses that supported investments in MBIA, members of the Warburg Pincus team that invested in MBIA, and Marty Davis, another MBIA investor who has voiced public support. Tom Brown's past blog posts outlined an excellent framework for evaluating RMBS pools. It would be extremely illuminating to understand the conclusions he or others reach by applying this approach to one or two of MBIA's second lien transactions and a representative sampling of RMBS tranches bundled into one of MBIA's riskiest CDOs.

Last modified on Sunday, 22 February 2009 23:00


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  • Comment Link phirang Monday, 23 February 2009 19:17 posted by phirang

    great thread:

  • Comment Link NDbadger Monday, 23 February 2009 15:18 posted by NDbadger

    That's a good question Shuan and I will try to find the answer for you. I imagine yes, but I'm sure that the response has varied.

    Many people have said that if Greenspan had cut the debt in the Long Term Capital Case, that it might have at least mitigated the current situation, as debt holders would have taken risk more seriously. And in the Great Depression, they did cut the debt holders, if I remember correctly.

    Keep in mind though that the magnitude of the losses in our case are so great, and the downfall is global, that even if in past crisis it wasn't generally done, it may still be done today. The more they do, the less it costs the taxpayer. Greg Mankiw at Harvard (Bush's former economic adviser) recently argued for just that scenario, as have many other prominent economists (Zingales, etc.). Indeed, I recently heard Chris Whalen (IRA) say that even though FNM & FRE junior debt hasn't been cut yet, he expects it to be cut when they do all the other banks, because, as with the other banks, the losses will be just too great for taxpayers to absorb.

    But ultimately it is a political question, with the bondholders versus the taxpayers. Here is a good clip by Martin Wolf on the subject. I don't usually pay any attention to Tech Ticker, but on this topic, they have been pretty good.

    Part 1:'s-Wolf-U.S.-Too-"Politically-Frightened"-to-Admit-Truth-About-Banks-Part-I?tickers=XLF,C,RBS,LYG,BCS,FAZ,SKF

    Part 2"Politically-Frightened"-to-Admit-Truth-About-Banks-FT's-Wolf-Says?tickers=XLF,SKF,FAZ,C,BAC,JPM,WFC

  • Comment Link hmc Monday, 23 February 2009 14:42 posted by hmc

    so if the this is all true and the CDO crash commeth; what stocks will be hit the hardest?

  • Comment Link shaunsnoll Monday, 23 February 2009 13:26 posted by shaunsnoll

    ND badger, was that how it was done in other countries when they nationalzied the banks? like in the nordic countries, and mexico, chile, etc.

  • Comment Link phirang Monday, 23 February 2009 13:21 posted by phirang

    If .gov nationalizes banks, the costs to .gov would force FFR up and kill our federal budget. We'd still dive to 200 on the S&P.

  • Comment Link NDbadger Monday, 23 February 2009 13:10 posted by NDbadger

    that's why I said that they have to do it all at once. because then the whole system implodes.

  • Comment Link phirang Monday, 23 February 2009 12:20 posted by phirang

    the whole system fails, since banks own OTHER BANK debt!

  • Comment Link NDbadger Monday, 23 February 2009 11:30 posted by NDbadger

    those are the reasons bondholders will likely take a hit, because the price tag is too big otherwise.

  • Comment Link phirang Monday, 23 February 2009 11:27 posted by phirang

    those are the problem!!!

  • Comment Link NDbadger Monday, 23 February 2009 11:25 posted by NDbadger

    if bondholders take the appropriate haircut, treasuries should be fine.

  • Comment Link phirang Monday, 23 February 2009 10:31 posted by phirang

    the trade of the century, if you think bank nationalization is imminent, is to short the 10 yr.

  • Comment Link shaunsnoll Monday, 23 February 2009 10:30 posted by shaunsnoll

    the treasury is easily more than big enough to takeover the banks without wiping out our country as long as bondholders are wiped out. the list of countries that have done this is long.

  • Comment Link NDbadger Monday, 23 February 2009 10:25 posted by NDbadger


    Nationalization of the big banks hasn't happened yet for several reasons. 1: because the bondholders are very powerful politically and are refusing to take a hit to their investment. Who are these bondholders? Other banks, insurance companies, and perhaps most importantly, central banks. But it's not the taxpayer's job to cover the banks' losses, it's the bondholders. But our political leaders are currently protecting the bondholders. I think (hope) as the losses continue to pile up, and the administration realizes that they can't afford to keep protecting the bondholders, this will change.

    Another reason nationalization hasn't happened yet is that it is most efficient to do it all at once. So seize C, BAC, JPM, WFC, PNC, etc. all at the same time. Yet many market participants still think JPM and WFC are solvent.

    A third reason is that the mechanism for handling large insolvent insurance companies isn't yet in place.

    Also, keep in mind that the smaller banks are being nationalized weekly. It's just done so quickly that nobody notices. The bigger banks will take longer because their operations are more diverse, but the approach is essentially the same.

    Here is an article by Luigi Zingales, a professor at the University of Chicago that should help to clarify.

  • Comment Link phirang Monday, 23 February 2009 10:08 posted by phirang

    what are you talking about? If nationalization weren't costly, it'd have been done already. The treasury market would collapse if the US nationalized the big banks.

  • Comment Link NDbadger Monday, 23 February 2009 10:04 posted by NDbadger

    Nationalization, done correctly, doesn't have to cost US taxpayers a lot. It's the bondholders that should take the haircut, and in most cases there is more than enough bondholder capital available to recapitalize the banking system.

    What we are watching, I believe, is a fight over who will pay for the financial system's losses. The new administration, at least on the surface, is following the path of the last administration and protecting bondholders. For now this may be the right thing to do, as long as they recognize that eventually all the big banks will be trading for around a dollar or two over the next few months. At that time, it will be time to step in to nationalize-and importantly let the bondholders recapitalize the banks.

  • Comment Link phirang Monday, 23 February 2009 09:15 posted by phirang

    The US can NOT afford to nationalize the banks without defaulting on the national debt/raising interest rates to 15%. Everything, at this point, is dependent on perpetuating the ponzi scheme that is our banking system (and by association, insurance as well).

    Btw, if FFR hits 15% next year, leadership of the world is up for grabs.

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