The next shoe to drop: bond insurers?
moneyrelations :: Jan.21.2008
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Okay, let’s face it. When you have Jane Q. Blogger like me writing about the state of the financial markets, it’s probably worse than it appears.
What’s the latest scare in the U.S. markets these days? Big bad bond insurers.
Whaaaat?
That’s all I’m reading about. Bond insurer Ambac Financial Group just got its triple-A credit rating downgraded to “AA” from the Fitch Ratings Agency. Competitor MBIA is also in trouble of a downgrade.
What’s the big deal?
Bonds are generally regarded as safe investment vehicles - more so when they are insured by triple-A rated bond insurers. These insurers are scrutinized for their ability to pay claims in case the bond issuer defaults on payments.
With Ambac being downgraded, it signals that the second-biggest bond insurer does not have enough capital to guarantee the billions of dollars of debt.
How did this happen?
It’s the word of 2007: subprime! Instead of sticking to the traditional municipal bonds, bond insurers looked for new business in the subprime industry and underestimated the risks they were taking.
What’s the fall out?
According to an article in the Washington Post:
Ambac and other bond insurers play an obscure but crucial role in capital markets by essentially transferring their ratings to the securities they guarantee. The downgrade of Ambac means many of those securities also will be downgraded, Fitch said.
This could spark a substantial sell-off by institutional investors such as pension funds that can only invest in top-rate securities, causing their value to drop. (. . .). The banks, which have already suffered staggering losses, have relied heavily on bond insurance to reduce their exposure to subprime mortgage debt and other complicated securities linked to these loans.
In other words, don’t be surprised to see more write-downs from banks and other financial services players.
And not to pile on, but this also causes problems for municipal issuers seeking to fund projects for roads, sewers, schools, etc. The cost of borrowing will go up as there are not enough credible insurance companies. But just one guess on who is there to pick up the slack: Warren Buffett and his new bond insurance company.
Investing ::
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