January 23, 2008
All AAA Ratings are Faux Ratings Now
Ambac, MBIA’s Lust for CDO Returns Undermined AAA Profitability, by Christine Richard
Good article which explains how muni bond insurers like MBIA and Ambac went astray.
“The crisis has been brewing for about six years, ever since the insurers discovered collateralized debt obligations … Insurers backed $127 billion of CDOs that relied at least partly on repayments on subprime home loans … Annual premiums on CDOs averaged 50 percent of the capital that the rating companies required the insurers to set aside, according to S&P. That compared with an average risk-adjusted profit ratio of 8 percent for insuring other types of structured- finance securities. What the insurers hadn’t bargained on was that the rating companies themselves, including S&P, had grossly underestimated the risk of CDOs.
… analysts failed to see that the mortgage market was becoming riskier. They relied instead on models to predict the performance of CDOs based on historical defaults, recovery rates and correlation risks for various credit ratings. They didn’t consider how piggyback loans, which are loans used to borrow a down payment, would perform when extended to people with a history of not paying their bills.”
Related:
Fine-tuning the Model to Reach the Desired Credit Rating
AMBAC Ack! MBIA DOA?
Patient Pershing’s Philanthropic Profit Pledge
Stock Du Jour (MCO) & Random Observations (August 15, 2007 — price charts don’t lie)
January 23rd, 2008 at 12:47 pm
They got greedy, wrote coverage for structured securities they didn’t understand and charged what they thought were fat premiums based on flawed model assumptions, and ruined their decades old, solid franchises.
Idiots.
The talking heads still paraded on CNBC today talking about a flight to safety to “highly rated bonds”. How the hell does a retail investor, or anyone, know what the real rating is of the underlying? They still don’t get it.
AAA rated companies paying 14% for capital? Come now. Ambac today released a statement expressing “excitement” about their future prospects. They are about to get downright hysterical.
January 23rd, 2008 at 2:44 pm
Cap: You have to wonder why the analysts (other than Ackman) weren’t deeply worried and writing reams about the shift in these insurers’ business models. So much for “efficient” markets, lol.
January 24th, 2008 at 5:50 am
Ackman shouldn’t be counting his chickens just yet.
The credit default swap market is a 25 trillion dollar zero-sum game. If you put on trades that worked so well that you bankrupt your counterparty, you will not collect on those trades.
I am just Mr.Nobody, a schlub, but even I can see that many punters are in no position to make good on their losses.
January 24th, 2008 at 5:54 am
As for the analysts, my response would exceed any reasonable wordcount limits!
January 24th, 2008 at 7:44 am
Cap: I thought Ackman was short the stocks so he shouldn’t face any counterparty risk when he covers, though I suppose it’s a different story with CDS (dunno, never bought or sold one myself).
January 24th, 2008 at 11:25 am
Oh yeah, you’re right.