Wednesday, May 28, 2008

Monolines back in the spotlight

(FT Alphaville) Yves Smith at Naked Capitalism picks up a piece in Tuesday’s New York Post - surprisingly, on collateralised debt obligations and monoline bond insurers.

In a nutshell, the Post is reporting that monolines are hampering banks’ efforts to liquidate CDOs.

The Post, we assume, is picking up on disputes such as this one, between XLCA and Merrill Lynch. The quid pro quo for cheap insurance on senior CDO tranches then appears to have been “control rights” over the liquidation of those CDOs in the event of default.

The whole thing is a legal mess. Existing CDO documentation would likely have given “control rights” to the most senior noteholders, not distant swap counterparties, so there’s plenty of room for disagreement.

But Smith wonders how this plays into the long-standing ‘you dont understand‘ defence the bond insurer’s have hitherto used. To wit, under existing CDO insurance contracts liabilities dont have to be met instantaneously, but gradually over a period of 20-30 years or so.

That, however, is rot - or at least, rotten - if it’s based solely on the legal sureity of those “control rights”, which is anything but certain.
Whatever the situation regarding paydown is, things broadly are once again, getting tricky for the remaining monolines. MBS fundamentals continue to deteriorate and impairment charges are already biting deep into freshly raised capital cushions at MBIA and Ambac. The FASB too, has just changed accounting rules, making further impairments all but inevitable.

The triple A is anything but secure.

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