Will Bond Insurer Bailout Work?
Monoline plan a respite, not resolution.
"What's the most you ever lost on a coin toss?"
Good morning and welcome back to the statue pack. On the heels of an Academy Awards that featured "One of the worst movies I've ever seen" winning Best Picture, we power up for a fresh set of reviews.
The plots are thick and the theater crowded as we anxiously await the twists and turns and market squirms. Investors are transfixed by the headlines, popcorn in hand, as they anticipate the bond insurer bailout plan they hope will keep critics at bay and save the day.
We all know the gory story from late Friday, when chatter emerged that a solution would be announced as early as today. That spiked the futures into the bell and littered hope throughout the weekend press. It also served as a real-time reminder that bathroom breaks can be quite costly as a function of the two-sided risk in today's tape.
While news has yet to hit the wires, I want to offer my two cents on the perceived monoline agreement. It is, from my perch, a respite rather than a resolution, a plan that will buy time rather than alleviate the underlying cause of stress.
It is in many ways an encapsulation of the mindset that has dominated policy since the back of the tech bubble. Give the drunk another drink with hopes he doesn't sober up. It's a conversation for another time and a different column but the similarities stand out. In the classic tradition of
This plan-one that will tap a consortium of banks for much needed capital-is borrowing from Peter to pay Paul. Banks will conceivably lend money to a company that is the counter-party to their own positions. They are protecting their own interests with hopes the credit contagion will be contained and ultimately lead to improvement.
It could happen, I suppose, but it's a tall order given the other side of zero-percent financing is staring us in the face. The underlying positions would effectively be on life support with credit cancer still looming large. There are a few observations that are worth noting as we fit the pieces together.
We've long spoken about the interwoven financial fabric tied together with a maze of derivatives. When Ambac (ABK), a company with a peak market capitalization of approximately $10 billion (and peak revenues of $1.8 billion) is considered too big to fail due to its counter party risk, it underscores that point.
The Super-conduit mechanism never materialized and the Term Auction Facility-initially postured as "temporary" fix but since left open "as needed-then emerged to inject "anonymous' liquidity to banks. Through that lens, this is a Fed bailout. The government distributed capital to the banks through the TAF, which in turn will purportedly pledge to the monoline insurers.
All of these caveats certainly don't prelude a relief rally. The bond insurers need capital to retain their investment grade status and they're in desperate need of a white knight. I'm reminded of the first Bank America (BAC) capital infusion into Countrywide (CFC). It helped for a spell but it was eventually overwhelmed with broader market forces.
As Mike O'Rourke, the savvy strategist from BTIG offered in his morning note:
"We will keep an open mind if a plan appears to reduce risk rather than reinforce it. So far, nothing that has been reported indicates that we are heading in that direction. It would be interesting to see the exposure of the final consortium. The Market will see if it is a real rescue, or just self-interested banks trying to delay inevitable losses."
We couldn't agree more.
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