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Thursday, December 20, 2007


end of the monoline

that's probably the easiest post title i'll ever have. monoline bond insurer MBIA today revealed -- after having hidden -- the fact that it is exposed to $8.1bn in CDO-squareds (or CDO^2s).

``We are shocked management withheld this information for as long as it did,'' Ken Zerbe, an analyst with Morgan Stanley in New York, wrote in a report yesterday. ``MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors.''

MBIA's ``eleventh-hour'' disclosure ``ignites concerns all over again about the prospect for future losses,'' Kathleen Shanley, an analyst at bond research firm Gimme Credit in Chicago, wrote in a report. She said outside investors didn't know about the CDOs-squared, which she called the riskiest type of CDO.

these are CDOs of the least-marketable tranches of CDOs, and one might quickly conclude they are now worth nothing. and while that may not be true, the very fact that MBIA holds $7bn in equity beneath some $30bn in CDOs and $650bn in total insurance is enough to make plain that it -- along with other monolines -- no longer merits a triple-a rating. without a triple-a rating, there's little point in the existence of a monoline. and the forbearance of the ratings agencies cannot last forever.

i think nouriel roubini has it right -- if the very existence of your business is predicated on a triple-a rating, you cannot merit a triple-a rating. the world of municipal finance can function without bond insurance, and it will shortly have to, though there might be significant losses as institutions are compelled to sell for regulatory reasons where they have up until now held fast.

in the longer run, i suspect borrowing for smaller and weaker communities will become significantly more expensive -- at exactly the wrong time.

more immediately vexing will be the default risk that many banks which own these CDOs and CDO^2s will, after having been laid off on the insurers, return to their own balance sheets and have to be reserved against. this should further exacerbate the capital hoarding that is at the core of the credit crunch.

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I've said the monolines business model is senseless since 2002, when I was introduced to them by an article in the WSJ describing a dispute between Bill Ackman (BA) of Gotham Partners and MBIA. In my opinion, BA was right on all counts. That the monolines have survived another five years only shows how slowly markets work.

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