Wednesday, April 23, 2008

Ambac: Wanna buy some death sticks?

You can read the actual news for yourself. Bottom line is they lost about 2 1/2 times their market value. Let that roll around in your mind for a while. CDS on Ambac's insurance sub (i.e., the AAA entity) is quoted at +750/year, up about 40bps. The parent company is 17 points up front +500bps/year, up 2 points from yesterday.

Haven't heard anything from the ratings agencies yet. As I've argued before, their AAA/Aaa rating on insured bonds is kind of academic at this point. They have $16 billion in claims paying resources, which means that they can probably pay off all insured bonds with cash to spare. Whether that merits a AAA or not is a matter of opinion. I think Ambac's stock is complete shit, but I also think shorting their insurance sub is dumb.

I'd also point out that the general market doesn't care much about Ambac's results. Dunno exactly how the stock market will open here, but the futures suggest slightly positive. Credit spreads away from monolines are opening mostly unchanged. Would there be any chance of a positive open given these results from Ambac 3 months ago?

Still no word from the ratings agencies. I'll point out that Moody's and S&P have previously argued that mark-to-market losses aren't indicitive of actual cash losses, and therefore the MTM losses Ambac is currently reporting aren't relevant. Not all of their $11/share loss was MTM, but worth considering. I still don't buy Ambac as a long-term profitable company. Maybe they can survive primarily as a reinsurer, but they'll never make it as a major muni insurer again. No way.


gramps said...

Calls of a possible bottom seem a bit premature. Yesterday, RBS took a mammoth sized write-off (GBP 5.9 billion -- or roughly USD 12 billion), plus it announced shareholders would be bailing out the bank to the tune of GBP 12 billion (RBS called it a "rights issue", commenters in the FT were less charitable). Today Ambac burped.

UPS (the package shipping company) also announced that they see the economy **starting** to slow (they had positive growth in January, followed by negative growth the rest of the quarter)... people are starting to realize this is NOT a liquidity problem, and there is zilch the Fed can do to make it better (although they can make it worse).

With the next Fed meeting a week away, a little contrast with the ECB is in order. While the Fed has completely panicked and lost control of the process to political forces-- the ECB has rather steadfastly stuck to its legal mandate to preserve pricing power.

While Bernanke screams about the sky falling and repeats his predecessors errors with excessively low rates, Trichet is acting in a much more rational and considered manner.

Yes, I know the "analysts" of Wall Street see it differently, but lets be honest and admit that Wall Street's track record isn't very good. Those who know work for hedge funds, those who don't go on CNBC.

In the U.S., the cost of living (even if you refuse to call it inflation) is skyrocketing. Consumers are drowning in debt they took during a period of excessively low interest rates that they can not afford to even service (much less pay off) in a normal interest rate environment. The US dollar is tanking. "The Maestro" Alan Greenspan even told the masses to switch into ARMS at precisely the worst time.... Excessively low interest rates made a few Wall Street bond traders fabulously wealthy, but most of Wall Street and most of Main Street are screwed. Thanks guys; great advice!

In Europe, the Euro is reaching all time highs against the failing dollar. Despite all the hysteria from Wall St (or London), the strong Euro has not caused economic chaos -- quite the contrary, French unemployment is at 25 year lows. German unions are demanding (and getting) substantial pay increases. And the massive real estate bubbles in London and Spain have not spread throughout Europe like they did in the U.S.

Accrued Interest said...

Gramps: Do you not acknowledge the possibility that bank writedowns will be priced in prior to the actual announcement? In other words, I don't need bank writedowns to end before starting to believe the worst is behind us.

It continues to baffle me that you don't acknowledge poor liuqidity as a problem, or even its existence. You and I have corresponded a lot and you know I mean no disrespect, but I think you are dead wrong about liquidity.

Explain why U.S. government gtd student loan ABS has widened by 100bps in the last 9 months. There is no logical reason other than poor liquidity.

gramps said...

AI - some write downs were obviously priced in; but Ambac's write downs were a bit bigger than expected. RBS's write downs were MUCH bigger than expected, and the rights issue is more than double what was expected by "the markets".

However, there are plenty of people on the buy-side and plenty of independent newsletters/advisory services that have been saying for months that Wall Street is deluding itself, and write downs will be much larger. Just about every bank CEO in the U.S. has gone on TV in the last 2 months saying the worst is behind us (Paulson has been saying so for almost a year) -- but then we have yet another much larger than expected write down, and we keep having them.

Total systemwide losses are going to amount to around USD 1 trillion, and so far write offs have been about 300-350 billion. There is a lot more to go. The Fed can delay some write-offs, but it cannot prevent them from happening eventually. Home prices, as a multiple of incomes, are just too high. Loans against overpriced houses will result in losses (irregardless of FF rates)-- its just a question of who takes the loss. Since many of these loans had absurd LTV ratios, much of the losses will hit banks and mortgage investors. There is no Fed Funds rate (higher or lower) that will change that.

As for liquidity issues: sure, insolvent people are by definition also illiquid. So of course there are liquidity issues -- but they are a symptom of the underlying insolvency problem. Liquidity itself is not the issue, and therefor Fed efforts to fix the wrong problem have been entirely unsuccessful. We keep having one analyst or another tell us the liquidity problem is solved, but whoops! another one pops up a week or so later-- when another player is feared to be insolvent. The Fed cannot lower FF 25bp everytime there is an insolvent player-- there are a lot more than 8 insolvent players remaining.

You cannot have a working economy where each person moves one house to the left and pays 20% more each year-- that isn't wealth creation. Pretending like we need to "save" this housing ponzi scheme is ridiculous.

The Fed cannot prevent economically unviable businesses from failing, nor can it prevent uneconomic loans from defaulting. 100% LTV loans to dubious borrowers will never be a viable business model at any Fed Funds rate -- and we should all stop kidding ourselves otherwise.

In a vain and foolish effort to prop up this failed model, Bernanke is flooding the system with excess credit and liquidity. It buys the uneconomic entities a little time, but they still fail. The cost is EVERYONE's savings gets decimated by inflation. Economically viable buisinesses have to divert attention away from real business decisions and try to guess what stupid thing the banks will do next. And the "man on the street" sees his politicians bailing out inept CEOs and concludes he shouldn't have to obey the rules either. It would be one thing if you were arguing for excessively low rates to preserve a viable economic model -- but that isn't what we are talking about.

An "investment" portfolio that depends on 20-1 or higher leverage isn't economically viable. Every market has a 5% correction at one time or another, so 20-1 is too high. Sure, you might get lucky for a while during a bull market, but its only a matter of time until you get a 5% correction and go belly up. Funds with this kind of leverage are not viable long term, so its not a liquidity issue when they are forced to reduce their leverage. Its just common sense returning.

The U.S. needs to follow its own advice -- the advice we give (and often impose) on every other country:
-- Don't bail out your cronies. Let bad businesses fail
-- The central bank should lend freely AT HIGH INTEREST RATES against GOOD collateral
-- We must live within our means. Since we are not, that means we must cut spending.

This is the advice we gave everyone else-- you know what they say about people who can't take their own medicine. The U.S. is acting childish, arrogantly figuring we can borrow way more than we could ever pay back and at absurdly low rates. Hundreds of banana republics have already tried this; and they all failed. This time will not be different.

We have plenty of liquidity for economically viable businesses. Unfortunately, a lot of this liquidity is now being diverted to finance unviable businesses. That misallocation of resources is going to hurt the U.S. for decades to come.

gramps said...

AI-- you also asked about the student loan ABS deal:

Banks are bailing out of the student loan business and SLM has basically said its business model won't work. Without massive taxpayer subsidies, its not a viable business. The loan is of dubious quality on its own merits.

You can claim it has a U.S. govt guarantee, but there are no funds allocated to back that guarantee... Congress is running massive deficits already. If a politician has to choose between cutting medicare or cutting subsidies to bond holders, gets who loses? Uncle Sam doesn't have the financial resources to actually stand behind all the promises he has made. I know some academic is going to suggest Uncle Sam is a risk free asset, but so was the Roman Empire. Like it or not, there are limits to how high taxes can go. California is a fairly liberal state, but when their property taxes went bezerk, they put a stop to unlimited govt funding. Same in New Jersey. Same in Canada. Tax evasion is a national pastime in much of Europe -- read about the squabbles between Germany and Lichtenstein over Germans avoiding taxes using Lichtenstein banks.

Whine all you want, but Uncle Sam does not have unlimited funding, even if we assume voters will lean more socialist in the next election (its looking like they will). The Fed's balance sheet has gone from 100% Treasuries to 50% Treasuries, 50% stuff no one can price properly. If they absolutely had to, Ambac could pay off its subprime guarantees (albeit with nothing left). Well, if it absolutely had to, the Fed CANNOT bail out JPM or BAC or Citi. It does not have the resources, period. Uncle Sam cannot bail out FNMA or FHLMC if it had to. If Congress had a trillion dollars lying around, they have at least a $40 trillion unfunded liability in entitlements.

I am NOT saying that Uncle Sam will collapse tomorrow. I am saying that there are no actual funds allocated to back a lot of the "government backed" bonds out there, and there is a very large existing deficit. With the current politics, its tough to see how anyone is going to find billions of additional spending authority-- so where would the money actually come from?

Face it: "U.S. government guaranteed" is only as good as the politics behind it. If they didn't vote money for it, the "promise" is going to be part of a comPROMISE.

Accrued Interest said...

You can't argue that a U.S. gtd is worthless while the 30 day T-Bill is yielding 0.70%.

And I've said several times its a liquidity problem and a real economy problem. I merely argue that the liquidty half appears to be improving, and I'd bet on that improvement holding.

If stocks had a liquidity crisis and a real economy crunch priced in as of early March, and if liquidity is improving, then stocks should probably be higher now.

gramps said...

A 30 day T-bill and a student loan ABS are not the same thing-- not economically, and definitely not politically. Even before the credit collapse, GNMA bonds never traded on par with Treasuries- why would you make this comparison between ABS and T-bills?

I am arguing that Congress is (present tense) being forced to make choices as to what "promises" it decides to keep and what get compromised on. Everyone was "ENTITLED" to get social security/medicare benefits, but once that became unrealistic, Congress had no hesitation to change the rules and make benefits "means tested".

Maybe you think the rich already have it too good, and this change is only fair. I won't argue that pro or con. I am simply saying that Congress can and does go back on its promises whenever it is politically expedient.

The market is widening the spread on your ABS because it knows the "guarantee" is written in pencil and can be retracted at any time. That isn't a liquidity issue, its just politics

gramps said...

Stocks are up, and will probably keep going up because there is too much money sloshing around, and not many good places to keep it.

Cash and bonds both pay negative real interest rates (and that's before you pay taxes on the nominal rate).

Stocks are an interest in an ongoing business. If that business is not a defunct financial operation, it has a future earnings stream. As long as the business has pricing power (so it can increase its product's pricing with inflation) -- its a better bet than cash or bonds.

And if you think Bernanke will continue to destroy the dollar (a really good bet IMHO) -- than stocks are clearly the way to go

Anonymous said...

The housing market is already pretty bad and it will only get worse. How can equity markets continue to go up from here with this mess on our hands?

gramps said...

Anon 9:35

Stocks aren't really going up, the dollar is going down. That makes stock prices (in nominal terms) go up, but inflation adjusted they are flat or possibly down

Anonymous said...

so if the dollar does a U-turn in the next few this would turn the equity markets too?