Wednesday, November 26, 2008

And NOW young monoline... you will die

Moody's has downgraded FSA and Assured Guaranty on Friday, claiming that with the future of municipal monoline insurance uncertain, it is unlikely that any stand-alone insurer could ever get a Aaa rating. I predicted the death of these insurers back in July when Moody's first put both on negative watch. For several months it appeared I was wrong, as either FSA or Assured wrapped approximately 22% of all new municipal issuance from August 1 to today. Assured's stock price rose from $11 to $17. They worked out a deal to re-insure CIFG's muni book. They agreed to purchase FSA. All in all it seemed like there were plenty of believers in municipal insurance.

But Moody's was the only doubter that mattered. Now municipal bond insurance is all but extinct.

Now I've outlined a good case for why municipal insurance should continue to live on. But forget about that. One can also make a case that FSA and/or Assured Guaranty shouldn't get a Aaa rating because of issues related to those companies specifically. But that's not what I want to talk about either.

What bothers me is Moody's assertion that demand for municipal bond insurance might decline and therefore no firm can get a Aaa rating.

Here is the problem with Moody's stance. It has nothing to do with their actual view of municipal insurance. Its painfully obvious that this is nothing more than CYA. Its like a referee doing a make-up call. They completely screwed up structured finance ratings from 2002-2007 or there abouts. And thus they have a lot of egg on their face in regards to FGIC, Ambac, MBIA, etc.

So now they want to act all tough and refuse to give Aaa ratings to monolines under any circumstances. Does this make any more sense than when they were giving out Aaa like business cards? Aren't they essentially making Assured Guaranty pay for the sins of FGIC?

Consider this. Let's say that a new municipal insurer is created and that insurer acquires all the municipal policies from Ambac. Now let's say that the new insurer has enough capital such that if it immediately went into run off, it could pay all realistic potential premiums with a significant cushion. What is "realistic" and "significant" in the previous sentence would need to be defined, but there is no reason why Moody's can't come up with those numbers.

Why can't such a firm be rated Aaa?

Notice how in the above scenario, the firm's ability to generate new revenue isn't relevant. The firm's ability to raise new capital isn't relevant. Its simply does the firm right now have adequate capital to pay its liabilities. Why is that concept so unreasonable?

For Moody's to claim they cannot rate on this basis is a total cop out, because this is exactly how all securitized deals are rated. A securitization is always a closed loop. The ratings have to be based on available capital versus expected losses. Obviously mistakes were made in rating securitized deals in recent years. But for Moody's to claim they cannot rate on such a basis is complete bullshit. Do we need to alter our models? Absolutely. But Moody's cannot on one hand claim to be a competent ratings agency and on the other hand claim they can't estimate muni losses versus available capital.

Municipal insurance benefited both investors and municipalities. Now it will die, all because Moody's doesn't have the courage to rate insurers based on dollars and cents. Instead they are rating based on public relations.

And by the way, why the hell has AGO's stock price risen since this news? They are toast, and I'm short.

13 comments:

Gringcorp said...

Well it wasn't the largest industry whose fortunes were based on the vagaries of the ratings process (I suspect that subprime mortgage origination takes that prize). But it was certainly the one most directly dependent on agency caprice. This is indeed absolutely mental. I'm sure the agencies would say that monoline exposures are so granular that they can throw the typical approach to rating insurance companies out the window. But this is an utter overreaction.

The Oriole Way said...

The rating agencies are a complete &#*$ing joke. Back in September, my company faced threat of downgrade because our stock started tanking and our CDS went bid. Had anything material changed? Nope. But, under threat of downgrade, we were forced to sell ourselves for below book value. The whole model needs to be overhauled.

rockain'tdeadyet said...

On another note: what's your opinion on this "quantitative easing" that's being used to explain the recent ridiculously low Treasury yields? Or, do you have any other explanation? I'm a bit baffled.

Don said...

"So now they want to act all tough and refuse to give Aaa ratings to monolines under any circumstances. Does this make any more sense than when they were giving out Aaa like business cards? Aren't they essentially making Assured Guaranty pay for the sins of FGIC?"

It made sense going up, because they made a lot more money. It makes sense going down because they were trading on their reputation going up, and they're trying to get it back now. In doing so, they are abetting, once again, not focusing on fundamentals.

The model here is broken. I be interested if you have read this, or I've missed your ideas on this problem:

http://www.glgroup.com/News/White-Paper-on-Rating-Competition-and-Structured-Finance-(Part-1)-23549.html

Don the libertarian Democrat

PNL4LYFE said...

I would suggest that even for a competent rating agency (oxymoron?) it's difficult if not impossible to predict municipal losses with any accuracy. So much is based on implicit guarantees by other levels of government. There's no doubt in my mind that some municipalities in CA will need State or federal money to remain solvent. Will CA be willing to provide it? If they are willing, will they be able to? At what point do the feds have to step in? I just don't think any model can account for the whims of politicians. To some extent, the same problem applies to corporates, particularly financials as we have seen.

rock: I think low yields are a symptom of many factors. The flight to quality is the most obvious. People don't want to own risky assets so they switch to Treasuries. Pension funds and insurance companies have long dated liabilities that they have to match regardless of whether the yield is attractive. Also, owner's of MBS have to buy bonds or receive fixed on swaps when rates fall because the duration of their MBS shortens.

Happy Thanksgiving to everyone.

kristof said...

I can see there might be some conflict of interest here, since insurers take money from the rating agencies (if you are insured, you don't really need to bother getting a rating).

Maybe a better insurance model would be a catastrophe-bond model like they use for natural disasters.

Accrued Interest said...

I admit that its tough to model muni defaults, but I don't think the ratings agencies should be allowed to just throw their hands up and say they can't do it.

Besides that's not really what Moody's is saying. They are saying they can't predict the future of muni insurance.

Kristof: They always assumed another Great Depression and estimated muni defaults from there. And the conflct of interest problem has always been there. Nothing has changed now. Besides, now a days, munis can't come to market without an underlying rating, so Moody's gets paid either way.

As far as low rates... I think you have a confluence of deflation, Asian selling of MBS/GSE debt and buying Tsy, and most recently, month-end buying by mutual funds. Mutual funds need to extend their duration every month-end to match the Barclays index. Normally that can cause a minor rally. But these days all markets are so thin that it creates a bigger rally.

There is also some impact from MBS hedging as PNL mentioned. There really isn't anything pushing rates the other way save for supply.

Tony Towers said...

Does a Moody's AAA rating have the same importance that it once had? I'm inclined to believe that a Moody's AA is now viewed as AAA. For example, if Moody's has an AA rating on a bond issue, but S&P and Fitch have an AAA rating I believe a municipality would discount the Moody's rating so long as the other two firms gave an AAA to the issue.

Martin said...

A friend in training at S&P many years ago was told by his mentor, "You seem to think that our job is to be predictive. That's not it at all. You won't get ahead here unless you understand that our job is to wait until the battle is over and then bayonet the wounded."

highlowbrow said...

Berkshire is still AAA, no? They insure municipals, no?And they own a big chunk of Moody's, no? Should I connect the dots for you?

Andrew said...

AA is the new AAA. Municipalities and bondi investores will adjust to this, and AGO's AA insurance will be sufficient. They are not toast. Cover your short.

Andrew said...

Also, even if they were not going to be able to write new business, the run-off value is way above the stock price. It is crazy to be short here.

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