Thursday, January 24, 2008

Worrisome signs for bond insurer bailout

(Naked Capitalism) I hate to be a nay-sayer, and I want to make it clear that it really would be for the best if New York State insurance superintendent Eric Dinallo could pull off a rescue of the troubled bond insurers. But as we pointed out, this is an uphill battle under the best of circumstances, and the initial tidbits dribbling out in the media from the discussions are not encouraging.

Before we get to the news items, let's go through a list of what makes this difficult:
1. Lack of a template. The closest parallel was the wind-down of Long Term Capital Management, in which 24 firms stumped up cash which served to shore up the firm. In LTCM's case, the exposures were known, the damage could be estimated with reasonable certainty, and the liquidation horizon wasn't that long. By contrast, here there are more institutions, both the insurers and the parties potentially at risk, more uncertainty as to total liability and how it might play out over time, and a longer time frame for liquidation, assuming the insurers are put in run-off mode.

2. Likely lack of involvement of top decision makers. The Fed called the heads of the 24 biggest firms (25 if you count Bear, which absented itself, much to the fury of everyone else) and was able to get their largely undivided attention for the days it took to hammer out a deal.

3. Lack of useful urgency. Time pressure is invaluable in getting a deal closed. While LTCM was at risk of a very immediate collapse, which helped focus the collective financial mind, here the immediate risk is of ratings downgrades. That would start a process of cascading selling by investors who are restricted to holding investments that meet certain rating thresholds that is widely expected to have nasty repercussions.

S&P and Moody's said they would review the two big insurers, MBIA and Ambac, within a week following Fitch's downgrade of Ambac after trading hours last Friday. There is no way a package can be in place by then, not even meaningful expressions of interest. Dinallo may be able to get the rating agencies to hold off another week, but even that addition of a still unrealistic amount of time to conclude a deal may be demotivating rather than energizing.

And if downgrade avoidance is not the reason to do a deal now, then there is no obvious deadline to force closure. The underlying exposures will bleed over time (although Pershing Square, the hedge fund that has done a great deal of analysis of the insurers and is heavily short, argues convincingly that MBIA will become insolvent at the holding company level by at the latest the end of 2008. However, even that does not impair the insurance contracts, which is what investors are worried about).

4. Complexity due to differing situations at each insurer. Related to, but separate from point 1. is that each insurer has a different mix of business. That means that even if Dinallo comes up with a template for one firm, it may have to be modified considerably to work elsewhere, In addition, MBIA has further complicating issues due to its dependence on its stuffee, um, reinsurer, ChannelRe.

5. Insufficient managerial bandwidth and competing management priorities. One of the scenarios I worried about last year was that several largish hedge funds going south at the same time. The fact that the LTCM rescue tied up the top brass on Wall Street, as well as some of the top lawyers, said that it would be logistically impossible to orchestrate multiple rescues on a compressed timeframe. Too many decisions and calls for action would fall on a very few key people. That would be true even in somewhat normal times. Now we have managements that are stressed with adverse business conditions and the need to make headcount cuts and other tough decisions.

6. Lack of clout. While Dinallo is as talented a guy as you can probably find both in the insurance industry and among regulators, he doesn't come close to commanding the authority of the Fed, or even the OCC. And while Timothy Geithner, the head of the New York Fed, and Henry Paulson are making supportive noises, there is not yet any sign that they are throwing their weight behind this effort.

7. Limited understanding of the banks and securities firms of the insurance industry. One factor that helped considerably in the LTCM rescue is that everyone was buzzword compatible. Running a big Wall Street firm and running a massive trading book like LTCM had are very very similar. No one in the rescue group had to get up to speed and everyone could communicate efficiently.

Insurance accounting is arcane and is not the same as GAAP. Indeed, most people who invest the time to learn the insurance business tend to specialize in it. That factor will make it harder for any investor to get his arms around the bond insurers' exposures and the natures of their risk. This communication/comprehension issue will also have the effect of creating delay.

8. Last but not least, this demand for more dough is coming precisely at a time when the industry (save Goldman) is hemmoraging capital.

Now to get to the less-than-encouraging sightings du jour. First from the New York Times:
Eric R. Dinallo, the New York insurance superintendent who regulates MBIA, called Wall Street executives on Tuesday to set up the meeting at his office in Lower Manhattan. He led the session on Wednesday and suggested that the group move in as little as 48 hours to get a deal done ahead of any downgrading of the bond guarantors by credit ratings firms.

According to two people, Mr. Dinallo said he would talk with the bankers one on one and reconvene the group — which included executives from Citigroup, Goldman Sachs and Merrill Lynch — on Thursday or Friday. Neither federal officials nor executives of the two insurers attended the meeting....

Mr. Dinallo could face resistance from banks that do not have significant exposure to the guarantors and thus have less incentive to put up money. It is also unclear how executives and shareholders of the companies would react to the plan and the prospect of ceding control.

Sean Dilweg, the commissioner of insurance in Wisconsin, which regulates Ambac, sat in on the meeting but said he would be working with Ambac directly. Mr. Dilweg said he met separately on Tuesday with executives at Ambac, which is based in New York but chartered in Wisconsin.

“Eric is looking at the overall issue, but I am pretty confident that we will work through Ambac’s specific issues,” Mr. Dilweg said in a telephone interview. “They are a stable and well-capitalized company but they have some choices to make.”

Other options open to the banks include providing lines of credit and other backup financing to the guarantors. A chief goal of any rescue would be to help the companies regain or keep triple-A credit ratings, which are seen as vital to their business.

There is one positive item, and if it would work this is a no-brainer. If a mere $15 billion in backup lines of credit would make this go away, the problem is trivial. But the agencies have to date said they want equity, not credit.

However the other signs are not encouraging. As much as Dinallo is trying to move things along as quickly as possible, it doesn't appear that he even has a group of funding sources that has agreed at least to explore this in a concerted fashion. A two hour meeting and further individual discussions, with a group meeting in the works but not yet firm, is the sign this program is in the organizational/selling/shape of the table stage. Until you get a committed, or close to committed group in a room and lock the doors, you haven't gotten things seriously underway, Even deals where everyone knows the playbook, like M&A, take days of full day sessions to hash out details. The fact that Dinallo wants to meet in 48 hours and "get a deal done" says that he may have perilous little appreciation of what it takes to get arrangements of this sort nailed down. Let's hope not.

It is also troubling that Dinallo is not in control. He is empowered to deal only regarding MBIA (not certain if any of the smaller bond insurers are under his purview), and has no authority regarding Ambac. And the moron of a regulator from Wisconsin is not only not on the same page, but is dumb enough to undermine Dinallo by saying to the press that all is well in the land of cheeseheads. The odds of Ambac pulling through look even more remote.

The Wall Street Journal was more downbeat than one might expect, comparing this effort to the failed SIV rescue plan. The Journal was unwittingly turned into a cheerleader on that one, so this may be a case of once burned, twice shy. Nevertheless:
A banker who attended the bailout discussions, between investment banks and New York Insurance Superintendent Eric Dinallo, said they were "very preliminary."

That is consistent with the Times' reporting, and not encouraging.

1 comment:

Anonymous said...

Caution: Now entering moral hazard zone