First Card of the CDS Game - ACA Downgraded to Junk

Now the whole house of cards built from Credit Default Swaps (CDS) is starting to come down. Yesterday the credit insurer ACA had its credit rating by Standard & Poor's cut all the way from "A" to "CCC". As I said last Friday the New York Stock Exchange announced they would delist them, so today's news was rather expected. A credit rating of "CCC" essentially means "bankrupt". This means that all the bonds they insured get their credit ratings lowered, and there will be big writedowns and maybe forced sales. Now we'll get to know who's been doing business with ACA. Canadian bank CIBC came out straight away and said that they have "insured" $3.5 billion of subprime loans with ACA. I suspect Merrill Lynch and Bear Stearns are feeling the heat too, because they have discussed "bailing out" ACA (to save themselves, I suppose). Even if this is possible, which I doubt, it would probably cost them billions. Then what happens when they have to bail out the next credit insurer that goes bust. FGIC, MBIA and Ambac are good candidates for this.
I started writing this post yesterday - and sure enough here we go today (the day after their AAA rating was affirmed by S&P) MBIA comes out and says that they "insured $8.1 billion of so-called CDOs-squared, which repackage other CDOs and securities linked to subprime mortgages". For those who don't know, CDO-squareds are considered very risky.
Things seem to be happening very quickly right now. What next? Will things quieten down over Christmas, or will we see more problems building up every day?

Potential problems in the CDS markets is something I mentioned already in my first post in August. Now it's starting to get serious.

The moral of the story is:
No insurance is safer than the insurance company itself!


Credit Insurers in Trouble

Reuters reports today that ACA Capital Holdings will be delisted by the New York Stock Exchange. ACA "provides financial guaranty insurance products to participants in the global credit derivatives markets, structured finance capital markets and municipal finance capital markets." In other words, it is a "monoline" credit insurer, just like MBIA and Ambac, that I have mentioned before on my "black list". ACA's shares have fallen from about $15 in June to about $0.50 today. Their latest economic report (from September 2007) is rather interesting - a net loss of about $-1 billion for the last quarter - total equity now about $-0.88 billion - meaning they are essentially bankrupt. The interesting thing is they have "insured" about $68 billion of "collateralized debt obligations" (CDOs), a form of repackaged debt. Now all that "insurance" is basically worthless. Who owns on all those "insured" CDOs? How did a company that had about $6 billion in total assets at the end of 2006 get to "insure" more than ten times as much in debt? It doesn't take a very high default rate on the underlying loans to erase the company. And who was stupid enough to pay for "insurance" from them? And by how many billions of dollars will they have to write their CDO assets down?
Now ACA is a comparatively small player in the CDS field. Ambac is one of the two biggest "monolines", and yesterday Bloomberg reported that Ambac reinsures $29 billion with Assured Guaranty Ltd., to "avoid the crippling loss of its AAA credit rating". On 5 December, Moody's basically gave Ambac and MBIA two weeks to raise more money or risk a credit rating downgrade. Ambac "guarantees" a mind-boggling $556 billion of securities, with total assets of only $22 billion and total equity of only $5.6 billion (as of September economic report). And they are losing money ($0.36 billion last quarter - I expect much more this quarter, cf. estimates for MBIA below). The deal with Assured Guaranty doesn't really change that much for Ambac - the riskiest debts are not included in the deal. And Ambac have so far not managed to raise any more money.
MBIA seems to be slightly better off - they managed to raise $1 billion from Warburg Pincus. MBIA "guarantees" $652 billion of securities, but their financial status is stronger than Ambac's - $45 billion in total assets, $6.5 billion in total equity and only lost $37 million last quarter. However, Barclays Capital expects MBIA to post losses of between $2.3 billion and $4.2 billion, which would of course make their financial situation precarious to say the least.
Now the string of credit insurers going bust seems to have started with ACA, and I expect Ambac to follow within a few months. MBIA could survive a year, perhaps. Some people might even think this is optimistic. According to Bloomberg "If all the companies were to falter, $2.4 trillion of insured securities would be thrown into doubt, costing as much as $200 billion". My guess is that cost is underestimated, as with all costs so far in this credit mess. However, the biggest risk if the credit insurers falter is that many of those who now hold the "insured" debt are only allowed to hold investment grade rated debt, or have a maximum percentage of non-investment grade debt that they may hold. This means that they would have to sell the "insured" debt if the insurers fail or are downgraded. This sudden selling would lead to lower prices for these classes of debt, thereby increasing losses, if buyers can be find at all in these frozen credit markets.
Ironically, Ambac announced yesterday that "International Securitisation Report (ISR) has named Ambac Monoline Insurer of the Year". Wow! Sounds really great, doesn't it? And it gets better: "Ambac has had an active year closing many noteworthy transactions. This award underscores the company's ability to use our in-depth knowledge and expertise to help issuers and financial advisors structure innovative transactions across a diverse range of asset classes and jurisdictions." It's a pity this award comes just as they seem to be on the brink of bankruptcy.


Norwegian Oil Production

The Norwegian Finance Minister Kristin Halvorsen is quoted today by Verdens Gang as saying "our oil can become worthless" because of "climate taxes" on burnt oil. She said this in Bali, where she flew for the climate meeting. Of course this climate meeting burns loads of fossil fuels just to get all the politicians there. But I suppose it is important that they get to discuss this, and shine a bit in the press before reality comes swooping in and they can't fly that much or that far any more. Later a spokesman for Halvorsen denied "considering cutting oil production for environmental concerns" and that "There is nothing in the government (program) declaration about a reduction in the pace of production" and "it was not an problematic issue".
However, reality says that the pace of oil production in Norway is problematic. Today Norway is the world's fifth largest oil exporter, pumping roughly 2.4 million barrels per day. However, production has fallen sharply since the top around the year 2000, and is not likely to reverse that trend. So even though what Kristin Halvorsen said was a bit confused, it is likely that they will have to use some kind of cover-up for why they are reducing their oil production.
Also, implying that their oil will become worth less in the future is pure nonsense. With world oil production probably in permanent decline, the remaining oil will on average just become worth more and more. Of course prices will jump up and down, depending on economic factors, but the main price trend for oil is up. It might even make sense for some big producer countries to voluntarily reduce their production in order to boost the price, thereby making even more money in the long run, and saving some of their reserves for hard times. So far, however, nobody seems interested in doing this, but time will tell whether we will see such policies in the future.