Commercial real estate, next shoe to drop....
James Quinn
January 19th 2009
America’s economy supports more than 1.1 million retail stores. There are approximately 1,100 Malls in the United States, not counting the thousands of strip mall centers. That will soon change as once thriving malls become ghost malls. By 2011, America’s malls within two years will have an entirely different set of numbers.
International Council of Shopping Centers (ICSC) chief economist Michael Niemira tries to put a good face on the gloom. He says, “In the midst of all this doom and gloom, it’s hard to imagine it getting better… But keep in mind, what happens in strong downturns is there’s a hefty pent-up demand. It’s wrong to extrapolate these conditions for the next year or two.”
But Mr. Niemira is probably wrong. There is no pent-up demand. Americans have bought everything they’ve desired for the last twenty years. The over-spending and over-leverage will take a decade to unwind.
According to the ICSC, about 150,000 stores are anticipated to shut down in 2009, in addition to the 150,000 that closed in 2008 and 135,000 in 2007. Normally, 110,000 to 125,000 new stores open per year. At least 700,000 of retail jobs will be lost. The opening of new stores will grind to a halt in 2009.
Some major retailers that have closed or will close include: Circuit City -728 stores; Linens N Things - 500 stores; Bombay Company- 384 stores; Sharper Image-184 stores; Foot Locker -140; Pacific Sunwear - 153. Other large retailers are closing underperforming stores and scaling back expansions plans. By 2011, at least 15% of the existing retail base will have gone to retail heaven. With the amount of vacant stores likely to be in excess of 200,000, there will be no need for the construction of new locations for many years.
Most of the retailers that are closing lease their locations from mall developers such as General Growth Properties, Simon Properties, Mills Corp., Pennsylvania REIT, and Vornado Realty Trust. These developers have a quadruple whammy hitting them in 2009. Many borrowed heavily to finance massive mall expansion. These loans were generally for five to seven year terms. The Wall Street wiz kids and their Collaterized Debt Obligation (CDO) machine generated the vast majority of financing in the last half decade.
According to commercial real estate expert Andy Miller, the collapse will come more rapidly than the residential collapse. “By contrast,” he says, “in the commercial world, the properties are fewer and much bigger. For example, you may have ten properties in a commercial pool that ultimately works its way into CDOs. Those loans are huge. You may have a shopping center loan in there for $25 million and an office building loan for $30 million dollars. As a result, if you have a default on just one of those loans, you can effectually wipe out all of the subordinate tranches.
Miller adds, “And that is why when you see the problems begin to appear on the commercial front. It’s going to be a much quicker sort of devolution than we saw on the residential side. In the commercial world, most of the financing that happened outside of the apartment business was done by conduits, and there are no more conduits left, and conduits were doing the stupidest loans you could find. They were doing an advertised 80 percent loan-to-value, which was usually more closely aligned to a 100 percent loan-to-value. They were dealing with no coverage. They were all non-recourse loans. Many of them were interest-only loans. Those loans are now gone. You can’t refinance them, and if you could, the terms would be onerous.”
The meltdown of materialism has hit the malls. For the last twenty years the American consumer has carried the weight of the world on its shoulders. This has been a heavy burden, but with consumers on steroids, it didn’t seem so heavy. The steroid of choice for the American consumer has been debt. They have utilized home equity loans, cash out refinancing, credit card debt, and auto loans to live far above their means. It has been a wild ride, but the ride is over. They can’t get steroids from their dealers (banks) anymore. The pseudo-wealth that has been created in the last twenty years has begun to unwind, but the deceleration will increase in 2009.
Average Americans, who saw their paper wealth growing rapidly as their home values increased, took advantage of this by refinancing their mortgages and extracting the equity from their homes and spending it. They sucked $3 trillion of equity out of their houses. Major Banks offered credit cards using your home equity as a way to pay everyday expenses like groceries, gas and clothes. Eating your house was never so easy. The massive number of excess home sales and equity withdrawal led to huge demand for home furnishings, remodeling services, appliances, electronic gadgets, BMWs, and exotic vacations. This led to massive expansion by retail and restaurant chains based on extrapolation of this demand. Enter mall mania.
But a psychological change has occurred in American consumers. They have lost $30 trillion in value from their homes and investments in the last two years. No amount of fiscal stimulation will reverse this psychological trauma. The savings rate will go from 0 percent to 8 percent. Mike Shedlock of Sitka Pacific Capital Management recently described the situation. “Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.” Now the impact of a retrenching consumer will be felt far and wide. Consumer spending has accounted for 70 percent of GDP. It will revert to at least.the long term mean of 65 percent.
David Rosenberg, the brilliant economist from Merrill Lynch, describes what will happen next: “This is an epic event; we’re talking about the end of a 20-year secular credit expansion that went absolutely parabolic from 2001-2007.Before the US economy can truly begin to expand again, the savings rate must rise to pre-bubble levels of 8 percent, US housing stocks must fall to below eight months’ supply, and the household interest coverage ratio must fall from 14 percent to 10.5 percent. It’s important to note what sort of surgery this is going to require. We will probably have to eliminate $2 trillion of household debt to get there. This will happen either through debt being written off, as major financial institutions continue to do, or for consumers themselves to shrink their own balance sheets.”
Billions of debt needs to be refinanced, and there is no one willing to make those loans. The major mall developers are so worried they have made an all out press to get a piece of the TARP. As retailers go bankrupt, vacancy rates have reached 9.4 percent for shopping centers, according to CoStar Group. With virtually no demand, rental income is plunging. With cap rates eroding and operating expenses going up, a perfect storm will hit mall developers in 2009.
The negative feedback loop will accelerate as the year progresses and will likely spiral out of control by late 2009 and early 2010. The negative feedback loop will lead to developer bankruptcies and ultimately to Ghost Malls, particularly in the outer suburbs. The collapse of developers will result in more major write-offs by banks. This time, many smaller regional banks will feel the major pain. The U.S. taxpayer will need to step up to the plate and assume responsibility for their lack of spending.
Mall owners and commercial developers are on the brink of bankruptcy. Commercial developer CB Richard Ellis didn’t sound too optimistic in a recent 10Q filing. He stated, “We are highly leveraged and have significant debt service obligations. Although our management believes that the incurrence of long-term indebtedness has been important in the development of our business, including facilitating our acquisitions of Insignia and Trammell Crow Company, the cash flow necessary to service this debt is not available for other general corporate purposes, which may limit our flexibility in planning for, or reacting to, changes in our business and in the commercial real estate services industry. Notwithstanding the actions described above, however, our level of indebtedness and the operating and financial restrictions in our debt agreements both place constraints on the operation of our business.”
As Americans realize that they don’t “need” a $5 Starbucks latte, IKEA knickknacks, Jimmy Choo shoes, Rolex watches, granite counters, and stainless steel appliances, our mall-centric world will end. As low prices become the only factor that drives retail sales, retailers will have lower profits in the future, further restricting expansion and renovations.
General Growth Properties, a mall developer which owns or operates 200 malls, added $4 billion of debt in the last three years and is teetering on the brink of bankruptcy. Simon Properties, which owns or operates 320 malls, added $3 billion of debt in the last three years and will be greatly affected by the coming downturn. Many smaller developers will be in even dire straits. With shrinking cash flow, looming debt refinancing, and dim prospects for a resumption of conspicuous consumption, Mall developers are destined for a bleak future.
Every major retailer in the United States has built their expansion plans on an assumption that American consumers would continue to spend at an unsustainable rate. That crucial assumption error will lead to the bankruptcy of any retailer that financed their expansion with debt. Warren Buffet’s wisdom will be borne out, “Only when the tide goes out do you discover who’s been swimming naked.”
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Showing posts with label rating agencies. Show all posts
Showing posts with label rating agencies. Show all posts
21 January 2009
14 January 2009
Risk rising for U.S., other nations' ratings - S&P
By Walden Siew
NEW YORK, Jan 13 (Reuters) - Standard & Poor's on Tuesday affirmed its "AAA" rating for the United States but said risks to the country's top sovereign grade have increased since the financial crisis deepened in September.
The ballooning costs of rescuing U.S. banks and auto companies, combined with an expected near-$1 trillion stimulus plan by President-elect Barack Obama, "will lead to noticeable deterioration in the U.S. fiscal profile," S&P said.
The Obama administration needs to "flesh out a medium-term strategy," David Beers, S&P's global head of sovereign ratings, said on a conference call. "There are a lot of unanswered questions."
The action was part of a broader review of 20 highly rated sovereign nations that resulted in affirmations for 12 "AAA" nations, including Australia, Austria, Canada, Denmark, Finland, France, Germany, Netherlands, Sweden, Switzerland and the United Kingdom.
S&P also affirmed its ratings for Belgium, Japan and Italy, while saying downgrades of investment-grade nations may be possible for New Zealand, Ireland, Spain, Portugal and Greece.
Rating firms are under fire for having given high ratings to home loans and complex bond packages that later plummeted in value and led to the collapse of the U.S. subprime mortgage market and so to the global financial crisis.
S&P, Moody's Investors Service and Fitch Ratings were "so wrong with subprime and structured finance," said Edward Grebeck, chief executive officer at Tempus Advisors in Stamford, Connecticut. "It's possible it's playing out with sovereigns now."
Two callers on S&P's call, including a JPMorgan Chase & Co analyst and an investor, questioned S&P's top rating for the United States.
"If the current situation isn't reason to look again at these triple-A ratings, what circumstances in the international arena would make you look at them again?" one caller said.
CREDIT SPREADS
The key will be the credit spreads of the countries, said Grebeck. "If you start to see the credit spreads out of line, that's evidence the ratings are out of line with reality."
The yield premium that most euro zone government bonds offer over German Bunds soared on Tuesday to record levels.
Ten-year Portuguese, French, Belgian, Greek, Spanish and Dutch bonds yielded the most over Bunds since at least 1999, when the euro was created, according to Reuters charts. For more see: ID:nLD484937.
The cost of protecting U.S. debt for five years fell to about 55 basis points on Tuesday, or $55,000 a year to protect $10 million of debt, from about 56 basis points late Monday, according to CMA DataVision.
S&P said U.S. strengths include one of the most flexible economies of any nation and the fact the U.S. dollar is one of the world's most used currencies.
Still, with net external debt at an estimated 240 percent of current account receipts, the United States remains vulnerable to any shift in international investors' willingness to buy dollar-denominated assets, S&P said.
S&P analyst John Chambers told Reuters in September that pressure was building on the U.S. "AAA" rating after the $85 billion bailout of insurer American International Group Inc.
Since then, the U.S. government has spent another $40 billion propping up AIG, $20 billion to bail out Citigroup and $19.4 billion to aid the auto industry.
S&P is expecting the U.S. general government deficit will double in 2009 from 5 percent of gross domestic product in fiscal year 2008.
A growing deficit will be the result of softening revenue sources and the incoming Obama administration's 2009 fiscal stimulus package, which S&P expects will approach $1 trillion, or 7 percent of GDP, a trend playing out globally.
Germany on Tuesday presented a 50 billion euro ($67 billion) stimulus package. [ID:nSP378771].
S&P said in a "reasonable worst-case scenario," U.S. net general government debt could rise from its 2008 level of 42 percent of GDP to as much as 75 percent by 2011, combining the costs of bailouts and stimulus with the fall-off in revenue.
Still, "I can't see them ever doing anything to the U.S. 'AAA' ratings because the U.S. dollar is the fundamental reserve currency in the world. Relative to other sovereigns, the U.S. is the best credit in the world" and deserving of its high rating for now, said Tempus' Grebeck.
But he added: "What we're seeing is cracks are beginning to show." (Additional reporting by Emelia Sithole-Matarise in London; Editing by James Dalgleish)
NEW YORK, Jan 13 (Reuters) - Standard & Poor's on Tuesday affirmed its "AAA" rating for the United States but said risks to the country's top sovereign grade have increased since the financial crisis deepened in September.
The ballooning costs of rescuing U.S. banks and auto companies, combined with an expected near-$1 trillion stimulus plan by President-elect Barack Obama, "will lead to noticeable deterioration in the U.S. fiscal profile," S&P said.
The Obama administration needs to "flesh out a medium-term strategy," David Beers, S&P's global head of sovereign ratings, said on a conference call. "There are a lot of unanswered questions."
The action was part of a broader review of 20 highly rated sovereign nations that resulted in affirmations for 12 "AAA" nations, including Australia, Austria, Canada, Denmark, Finland, France, Germany, Netherlands, Sweden, Switzerland and the United Kingdom.
S&P also affirmed its ratings for Belgium, Japan and Italy, while saying downgrades of investment-grade nations may be possible for New Zealand, Ireland, Spain, Portugal and Greece.
Rating firms are under fire for having given high ratings to home loans and complex bond packages that later plummeted in value and led to the collapse of the U.S. subprime mortgage market and so to the global financial crisis.
S&P, Moody's Investors Service and Fitch Ratings were "so wrong with subprime and structured finance," said Edward Grebeck, chief executive officer at Tempus Advisors in Stamford, Connecticut. "It's possible it's playing out with sovereigns now."
Two callers on S&P's call, including a JPMorgan Chase & Co analyst and an investor, questioned S&P's top rating for the United States.
"If the current situation isn't reason to look again at these triple-A ratings, what circumstances in the international arena would make you look at them again?" one caller said.
CREDIT SPREADS
The key will be the credit spreads of the countries, said Grebeck. "If you start to see the credit spreads out of line, that's evidence the ratings are out of line with reality."
The yield premium that most euro zone government bonds offer over German Bunds soared on Tuesday to record levels.
Ten-year Portuguese, French, Belgian, Greek, Spanish and Dutch bonds yielded the most over Bunds since at least 1999, when the euro was created, according to Reuters charts. For more see: ID:nLD484937.
The cost of protecting U.S. debt for five years fell to about 55 basis points on Tuesday, or $55,000 a year to protect $10 million of debt, from about 56 basis points late Monday, according to CMA DataVision.
S&P said U.S. strengths include one of the most flexible economies of any nation and the fact the U.S. dollar is one of the world's most used currencies.
Still, with net external debt at an estimated 240 percent of current account receipts, the United States remains vulnerable to any shift in international investors' willingness to buy dollar-denominated assets, S&P said.
S&P analyst John Chambers told Reuters in September that pressure was building on the U.S. "AAA" rating after the $85 billion bailout of insurer American International Group Inc.
Since then, the U.S. government has spent another $40 billion propping up AIG, $20 billion to bail out Citigroup and $19.4 billion to aid the auto industry.
S&P is expecting the U.S. general government deficit will double in 2009 from 5 percent of gross domestic product in fiscal year 2008.
A growing deficit will be the result of softening revenue sources and the incoming Obama administration's 2009 fiscal stimulus package, which S&P expects will approach $1 trillion, or 7 percent of GDP, a trend playing out globally.
Germany on Tuesday presented a 50 billion euro ($67 billion) stimulus package. [ID:nSP378771].
S&P said in a "reasonable worst-case scenario," U.S. net general government debt could rise from its 2008 level of 42 percent of GDP to as much as 75 percent by 2011, combining the costs of bailouts and stimulus with the fall-off in revenue.
Still, "I can't see them ever doing anything to the U.S. 'AAA' ratings because the U.S. dollar is the fundamental reserve currency in the world. Relative to other sovereigns, the U.S. is the best credit in the world" and deserving of its high rating for now, said Tempus' Grebeck.
But he added: "What we're seeing is cracks are beginning to show." (Additional reporting by Emelia Sithole-Matarise in London; Editing by James Dalgleish)
5 January 2009
NYT ~ The End of the Financial World as We Know It
AMERICANS enter the New Year in a strange new role: financial lunatics. We’ve been viewed by the wider world with mistrust and suspicion on other matters, but on the subject of money even our harshest critics have been inclined to believe that we knew what we were doing. They watched our investment bankers and emulated them: for a long time now half the planet’s college graduates seemed to want nothing more out of life than a job on Wall Street.
This is one reason the collapse of our financial system has inspired not merely a national but a global crisis of confidence. Good God, the world seems to be saying, if they don’t know what they are doing with money, who does?
Incredibly, intelligent people the world over remain willing to lend us money and even listen to our advice; they appear not to have realized the full extent of our madness. We have at least a brief chance to cure ourselves. But first we need to ask: of what?
To that end consider the strange story of Harry Markopolos. Mr. Markopolos is the former investment officer with Rampart Investment Management in Boston who, for nine years, tried to explain to the Securities and Exchange Commission that Bernard L. Madoff couldn’t be anything other than a fraud. Mr. Madoff’s investment performance, given his stated strategy, was not merely improbable but mathematically impossible. And so, Mr. Markopolos reasoned, Bernard Madoff must be doing something other than what he said he was doing.
In his devastatingly persuasive 17-page letter to the S.E.C., Mr. Markopolos saw two possible scenarios. In the “Unlikely” scenario: Mr. Madoff, who acted as a broker as well as an investor, was “front-running” his brokerage customers. A customer might submit an order to Madoff Securities to buy shares in I.B.M. at a certain price, for example, and Madoff Securities instantly would buy I.B.M. shares for its own portfolio ahead of the customer order. If I.B.M.’s shares rose, Mr. Madoff kept them; if they fell he fobbed them off onto the poor customer.
In the “Highly Likely” scenario, wrote Mr. Markopolos, “Madoff Securities is the world’s largest Ponzi Scheme.” Which, as we now know, it was.
Harry Markopolos sent his report to the S.E.C. on Nov. 7, 2005 — more than three years before Mr. Madoff was finally exposed — but he had been trying to explain the fraud to them since 1999. He had no direct financial interest in exposing Mr. Madoff — he wasn’t an unhappy investor or a disgruntled employee. There was no way to short shares in Madoff Securities, and so Mr. Markopolos could not have made money directly from Mr. Madoff’s failure. To judge from his letter, Harry Markopolos anticipated mainly downsides for himself: he declined to put his name on it for fear of what might happen to him and his family if anyone found out he had written it. And yet the S.E.C.’s cursory investigation of Mr. Madoff pronounced him free of fraud.
What’s interesting about the Madoff scandal, in retrospect, is how little interest anyone inside the financial system had in exposing it. It wasn’t just Harry Markopolos who smelled a rat. As Mr. Markopolos explained in his letter, Goldman Sachs was refusing to do business with Mr. Madoff; many others doubted Mr. Madoff’s profits or assumed he was front-running his customers and steered clear of him. Between the lines, Mr. Markopolos hinted that even some of Mr. Madoff’s investors may have suspected that they were the beneficiaries of a scam. After all, it wasn’t all that hard to see that the profits were too good to be true. Some of Mr. Madoff’s investors may have reasoned that the worst that could happen to them, if the authorities put a stop to the front-running, was that a good thing would come to an end.
The Madoff scandal echoes a deeper absence inside our financial system, which has been undermined not merely by bad behavior but by the lack of checks and balances to discourage it. “Greed” doesn’t cut it as a satisfying explanation for the current financial crisis. Greed was necessary but insufficient; in any case, we are as likely to eliminate greed from our national character as we are lust and envy. The fixable problem isn’t the greed of the few but the misaligned interests of the many.
A lot has been said and written, for instance, about the corrupting effects on Wall Street of gigantic bonuses. What happened inside the major Wall Street firms, though, was more deeply unsettling than greedy people lusting for big checks: leaders of public corporations, especially financial corporations, are as good as required to lead for the short term.
Richard Fuld, the former chief executive of Lehman Brothers, E. Stanley O’Neal, the former chief executive of Merrill Lynch, and Charles O. Prince III, Citigroup’s chief executive, may have paid themselves humongous sums of money at the end of each year, as a result of the bond market bonanza. But if any one of them had set himself up as a whistleblower — had stood up and said “this business is irresponsible and we are not going to participate in it” — he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he’d be replaced by someone willing to make money from the credit bubble.
OUR financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest.
The credit-rating agencies, for instance.
Everyone now knows that Moody’s and Standard & Poor’s botched their analyses of bonds backed by home mortgages. But their most costly mistake — one that deserves a lot more attention than it has received — lies in their area of putative expertise: measuring corporate risk.
Over the last 20 years American financial institutions have taken on more and more risk, with the blessing of regulators, with hardly a word from the rating agencies, which, incidentally, are paid by the issuers of the bonds they rate. Seldom if ever did Moody’s or Standard & Poor’s say, “If you put one more risky asset on your balance sheet, you will face a serious downgrade.”
The American International Group, Fannie Mae, Freddie Mac, General Electric and the municipal bond guarantors Ambac Financial and MBIA all had triple-A ratings. (G.E. still does!) Large investment banks like Lehman and Merrill Lynch all had solid investment grade ratings. It’s almost as if the higher the rating of a financial institution, the more likely it was to contribute to financial catastrophe. But of course all these big financial companies fueled the creation of the credit products that in turn fueled the revenues of Moody’s and Standard & Poor’s.
These oligopolies, which are actually sanctioned by the S.E.C., didn’t merely do their jobs badly. They didn’t simply miss a few calls here and there. In pursuit of their own short-term earnings, they did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it.
This is a subject that might be profitably explored in Washington. There are many questions an enterprising United States senator might want to ask the credit-rating agencies. Here is one: Why did you allow MBIA to keep its triple-A rating for so long? In 1990 MBIA was in the relatively simple business of insuring municipal bonds. It had $931 million in equity and only $200 million of debt — and a plausible triple-A rating.
By 2006 MBIA had plunged into the much riskier business of guaranteeing collateralized debt obligations, or C.D.O.’s. But by then it had $7.2 billion in equity against an astounding $26.2 billion in debt. That is, even as it insured ever-greater risks in its business, it also took greater risks on its balance sheet.
Yet the rating agencies didn’t so much as blink. On Wall Street the problem was hardly a secret: many people understood that MBIA didn’t deserve to be rated triple-A. As far back as 2002, a hedge fund called Gotham Partners published a persuasive report, widely circulated, entitled: “Is MBIA Triple A?” (The answer was obviously no.)
At the same time, almost everyone believed that the rating agencies would never downgrade MBIA, because doing so was not in their short-term financial interest. A downgrade of MBIA would force the rating agencies to go through the costly and cumbersome process of re-rating tens of thousands of credits that bore triple-A ratings simply by virtue of MBIA’s guarantee. It would stick a wrench in the machine that enriched them. (In June, finally, the rating agencies downgraded MBIA, after MBIA’s failure became such an open secret that nobody any longer cared about its formal credit rating.)
The S.E.C. now promises modest new measures to contain the damage that the rating agencies can do — measures that fail to address the central problem: that the raters are paid by the issuers.
But this should come as no surprise, for the S.E.C. itself is plagued by similarly wacky incentives. Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.
Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors. (The task it has performed most diligently during this crisis has been to question, intimidate and impose rules on short-sellers — the only market players who have a financial incentive to expose fraud and abuse.)
The instinct to avoid short-term political heat is part of the problem; anything the S.E.C. does to roil the markets, or reduce the share price of any given company, also roils the careers of the people who run the S.E.C. Thus it seldom penalizes serious corporate and management malfeasance — out of some misguided notion that to do so would cause stock prices to fall, shareholders to suffer and confidence to be undermined. Preserving confidence, even when that confidence is false, has been near the top of the S.E.C.’s agenda.
IT’S not hard to see why the S.E.C. behaves as it does. If you work for the enforcement division of the S.E.C. you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it.
The commission’s most recent director of enforcement is the general counsel at JPMorgan Chase; the enforcement chief before him became general counsel at Deutsche Bank; and one of his predecessors became a managing director for Credit Suisse before moving on to Morgan Stanley. A casual observer could be forgiven for thinking that the whole point of landing the job as the S.E.C.’s director of enforcement is to position oneself for the better paying one on Wall Street.
At the back of the version of Harry Markopolos’s brave paper currently making the rounds is a copy of an e-mail message, dated April 2, 2008, from Mr. Markopolos to Jonathan S. Sokobin. Mr. Sokobin was then the new head of the commission’s office of risk assessment, a job that had been vacant for more than a year after its previous occupant had left to — you guessed it — take a higher-paying job on Wall Street.
At any rate, Mr. Markopolos clearly hoped that a new face might mean a new ear — one that might be receptive to the truth. He phoned Mr. Sokobin and then sent him his paper. “Attached is a submission I’ve made to the S.E.C. three times in Boston,” he wrote. “Each time Boston sent this to New York. Meagan Cheung, branch chief, in New York actually investigated this but with no result that I am aware of. In my conversations with her, I did not believe that she had the derivatives or mathematical background to understand the violations.”
How does this happen? How can the person in charge of assessing Wall Street firms not have the tools to understand them? Is the S.E.C. that inept? Perhaps, but the problem inside the commission is far worse — because inept people can be replaced. The problem is systemic. The new director of risk assessment was no more likely to grasp the risk of Bernard Madoff than the old director of risk assessment because the new guy’s thoughts and beliefs were guided by the same incentives: the need to curry favor with the politically influential and the desire to keep sweet the Wall Street elite.
And here’s the most incredible thing of all: 18 months into the most spectacular man-made financial calamity in modern experience, nothing has been done to change that, or any of the other bad incentives that led us here in the first place.
SAY what you will about our government’s approach to the financial crisis, you cannot accuse it of wasting its energy being consistent or trying to win over the masses. In the past year there have been at least seven different bailouts, and six different strategies. And none of them seem to have pleased anyone except a handful of financiers.
When Bear Stearns failed, the government induced JPMorgan Chase to buy it by offering a knockdown price and guaranteeing Bear Stearns’s shakiest assets. Bear Stearns bondholders were made whole and its stockholders lost most of their money.
Then came the collapse of the government-sponsored entities, Fannie Mae and Freddie Mac, both promptly nationalized. Management was replaced, shareholders badly diluted, creditors left intact but with some uncertainty. Next came Lehman Brothers, which was, of course, allowed to go bankrupt. At first, the Treasury and the Federal Reserve claimed they had allowed Lehman to fail in order to signal that recklessly managed Wall Street firms did not all come with government guarantees; but then, when chaos ensued, and people started saying that letting Lehman fail was a dumb thing to have done, they changed their story and claimed they lacked the legal authority to rescue the firm.
But then a few days later A.I.G. failed, or tried to, yet was given the gift of life with enormous government loans. Washington Mutual and Wachovia promptly followed: the first was unceremoniously seized by the Treasury, wiping out both its creditors and shareholders; the second was batted around for a bit. Initially, the Treasury tried to persuade Citigroup to buy it — again at a knockdown price and with a guarantee of the bad assets. (The Bear Stearns model.) Eventually, Wachovia went to Wells Fargo, after the Internal Revenue Service jumped in and sweetened the pot with a tax subsidy.
In the middle of all this, Treasury Secretary Henry M. Paulson Jr. persuaded Congress that he needed $700 billion to buy distressed assets from banks — telling the senators and representatives that if they didn’t give him the money the stock market would collapse. Once handed the money, he abandoned his promised strategy, and instead of buying assets at market prices, began to overpay for preferred stocks in the banks themselves. Which is to say that he essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival. The stock market fell anyway.
It’s hard to know what Mr. Paulson was thinking as he never really had to explain himself, at least not in public. But the general idea appears to be that if you give the banks capital they will in turn use it to make loans in order to stimulate the economy. Never mind that if you want banks to make smart, prudent loans, you probably shouldn’t give money to bankers who sunk themselves by making a lot of stupid, imprudent ones. If you want banks to re-lend the money, you need to provide them not with preferred stock, which is essentially a loan, but with tangible common equity — so that they might write off their losses, resolve their troubled assets and then begin to make new loans, something they won’t be able to do until they’re confident in their own balance sheets. But as it happened, the banks took the taxpayer money and just sat on it.
Continued at "How to Repair a Broken Financial World."
Michael Lewis, a contributing editor at Vanity Fair and the author of “Liar’s Poker,” is writing a book about the collapse of Wall Street. David Einhorn is the president of Greenlight Capital, a hedge fund, and the author of “Fooling Some of the People All of the Time.” Investment accounts managed by Greenlight may have a position (long or short) in the securities discussed in this article.
This is one reason the collapse of our financial system has inspired not merely a national but a global crisis of confidence. Good God, the world seems to be saying, if they don’t know what they are doing with money, who does?
Incredibly, intelligent people the world over remain willing to lend us money and even listen to our advice; they appear not to have realized the full extent of our madness. We have at least a brief chance to cure ourselves. But first we need to ask: of what?
To that end consider the strange story of Harry Markopolos. Mr. Markopolos is the former investment officer with Rampart Investment Management in Boston who, for nine years, tried to explain to the Securities and Exchange Commission that Bernard L. Madoff couldn’t be anything other than a fraud. Mr. Madoff’s investment performance, given his stated strategy, was not merely improbable but mathematically impossible. And so, Mr. Markopolos reasoned, Bernard Madoff must be doing something other than what he said he was doing.
In his devastatingly persuasive 17-page letter to the S.E.C., Mr. Markopolos saw two possible scenarios. In the “Unlikely” scenario: Mr. Madoff, who acted as a broker as well as an investor, was “front-running” his brokerage customers. A customer might submit an order to Madoff Securities to buy shares in I.B.M. at a certain price, for example, and Madoff Securities instantly would buy I.B.M. shares for its own portfolio ahead of the customer order. If I.B.M.’s shares rose, Mr. Madoff kept them; if they fell he fobbed them off onto the poor customer.
In the “Highly Likely” scenario, wrote Mr. Markopolos, “Madoff Securities is the world’s largest Ponzi Scheme.” Which, as we now know, it was.
Harry Markopolos sent his report to the S.E.C. on Nov. 7, 2005 — more than three years before Mr. Madoff was finally exposed — but he had been trying to explain the fraud to them since 1999. He had no direct financial interest in exposing Mr. Madoff — he wasn’t an unhappy investor or a disgruntled employee. There was no way to short shares in Madoff Securities, and so Mr. Markopolos could not have made money directly from Mr. Madoff’s failure. To judge from his letter, Harry Markopolos anticipated mainly downsides for himself: he declined to put his name on it for fear of what might happen to him and his family if anyone found out he had written it. And yet the S.E.C.’s cursory investigation of Mr. Madoff pronounced him free of fraud.
What’s interesting about the Madoff scandal, in retrospect, is how little interest anyone inside the financial system had in exposing it. It wasn’t just Harry Markopolos who smelled a rat. As Mr. Markopolos explained in his letter, Goldman Sachs was refusing to do business with Mr. Madoff; many others doubted Mr. Madoff’s profits or assumed he was front-running his customers and steered clear of him. Between the lines, Mr. Markopolos hinted that even some of Mr. Madoff’s investors may have suspected that they were the beneficiaries of a scam. After all, it wasn’t all that hard to see that the profits were too good to be true. Some of Mr. Madoff’s investors may have reasoned that the worst that could happen to them, if the authorities put a stop to the front-running, was that a good thing would come to an end.
The Madoff scandal echoes a deeper absence inside our financial system, which has been undermined not merely by bad behavior but by the lack of checks and balances to discourage it. “Greed” doesn’t cut it as a satisfying explanation for the current financial crisis. Greed was necessary but insufficient; in any case, we are as likely to eliminate greed from our national character as we are lust and envy. The fixable problem isn’t the greed of the few but the misaligned interests of the many.
A lot has been said and written, for instance, about the corrupting effects on Wall Street of gigantic bonuses. What happened inside the major Wall Street firms, though, was more deeply unsettling than greedy people lusting for big checks: leaders of public corporations, especially financial corporations, are as good as required to lead for the short term.
Richard Fuld, the former chief executive of Lehman Brothers, E. Stanley O’Neal, the former chief executive of Merrill Lynch, and Charles O. Prince III, Citigroup’s chief executive, may have paid themselves humongous sums of money at the end of each year, as a result of the bond market bonanza. But if any one of them had set himself up as a whistleblower — had stood up and said “this business is irresponsible and we are not going to participate in it” — he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he’d be replaced by someone willing to make money from the credit bubble.
OUR financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest.
The credit-rating agencies, for instance.
Everyone now knows that Moody’s and Standard & Poor’s botched their analyses of bonds backed by home mortgages. But their most costly mistake — one that deserves a lot more attention than it has received — lies in their area of putative expertise: measuring corporate risk.
Over the last 20 years American financial institutions have taken on more and more risk, with the blessing of regulators, with hardly a word from the rating agencies, which, incidentally, are paid by the issuers of the bonds they rate. Seldom if ever did Moody’s or Standard & Poor’s say, “If you put one more risky asset on your balance sheet, you will face a serious downgrade.”
The American International Group, Fannie Mae, Freddie Mac, General Electric and the municipal bond guarantors Ambac Financial and MBIA all had triple-A ratings. (G.E. still does!) Large investment banks like Lehman and Merrill Lynch all had solid investment grade ratings. It’s almost as if the higher the rating of a financial institution, the more likely it was to contribute to financial catastrophe. But of course all these big financial companies fueled the creation of the credit products that in turn fueled the revenues of Moody’s and Standard & Poor’s.
These oligopolies, which are actually sanctioned by the S.E.C., didn’t merely do their jobs badly. They didn’t simply miss a few calls here and there. In pursuit of their own short-term earnings, they did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it.
This is a subject that might be profitably explored in Washington. There are many questions an enterprising United States senator might want to ask the credit-rating agencies. Here is one: Why did you allow MBIA to keep its triple-A rating for so long? In 1990 MBIA was in the relatively simple business of insuring municipal bonds. It had $931 million in equity and only $200 million of debt — and a plausible triple-A rating.
By 2006 MBIA had plunged into the much riskier business of guaranteeing collateralized debt obligations, or C.D.O.’s. But by then it had $7.2 billion in equity against an astounding $26.2 billion in debt. That is, even as it insured ever-greater risks in its business, it also took greater risks on its balance sheet.
Yet the rating agencies didn’t so much as blink. On Wall Street the problem was hardly a secret: many people understood that MBIA didn’t deserve to be rated triple-A. As far back as 2002, a hedge fund called Gotham Partners published a persuasive report, widely circulated, entitled: “Is MBIA Triple A?” (The answer was obviously no.)
At the same time, almost everyone believed that the rating agencies would never downgrade MBIA, because doing so was not in their short-term financial interest. A downgrade of MBIA would force the rating agencies to go through the costly and cumbersome process of re-rating tens of thousands of credits that bore triple-A ratings simply by virtue of MBIA’s guarantee. It would stick a wrench in the machine that enriched them. (In June, finally, the rating agencies downgraded MBIA, after MBIA’s failure became such an open secret that nobody any longer cared about its formal credit rating.)
The S.E.C. now promises modest new measures to contain the damage that the rating agencies can do — measures that fail to address the central problem: that the raters are paid by the issuers.
But this should come as no surprise, for the S.E.C. itself is plagued by similarly wacky incentives. Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.
Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors. (The task it has performed most diligently during this crisis has been to question, intimidate and impose rules on short-sellers — the only market players who have a financial incentive to expose fraud and abuse.)
The instinct to avoid short-term political heat is part of the problem; anything the S.E.C. does to roil the markets, or reduce the share price of any given company, also roils the careers of the people who run the S.E.C. Thus it seldom penalizes serious corporate and management malfeasance — out of some misguided notion that to do so would cause stock prices to fall, shareholders to suffer and confidence to be undermined. Preserving confidence, even when that confidence is false, has been near the top of the S.E.C.’s agenda.
IT’S not hard to see why the S.E.C. behaves as it does. If you work for the enforcement division of the S.E.C. you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it.
The commission’s most recent director of enforcement is the general counsel at JPMorgan Chase; the enforcement chief before him became general counsel at Deutsche Bank; and one of his predecessors became a managing director for Credit Suisse before moving on to Morgan Stanley. A casual observer could be forgiven for thinking that the whole point of landing the job as the S.E.C.’s director of enforcement is to position oneself for the better paying one on Wall Street.
At the back of the version of Harry Markopolos’s brave paper currently making the rounds is a copy of an e-mail message, dated April 2, 2008, from Mr. Markopolos to Jonathan S. Sokobin. Mr. Sokobin was then the new head of the commission’s office of risk assessment, a job that had been vacant for more than a year after its previous occupant had left to — you guessed it — take a higher-paying job on Wall Street.
At any rate, Mr. Markopolos clearly hoped that a new face might mean a new ear — one that might be receptive to the truth. He phoned Mr. Sokobin and then sent him his paper. “Attached is a submission I’ve made to the S.E.C. three times in Boston,” he wrote. “Each time Boston sent this to New York. Meagan Cheung, branch chief, in New York actually investigated this but with no result that I am aware of. In my conversations with her, I did not believe that she had the derivatives or mathematical background to understand the violations.”
How does this happen? How can the person in charge of assessing Wall Street firms not have the tools to understand them? Is the S.E.C. that inept? Perhaps, but the problem inside the commission is far worse — because inept people can be replaced. The problem is systemic. The new director of risk assessment was no more likely to grasp the risk of Bernard Madoff than the old director of risk assessment because the new guy’s thoughts and beliefs were guided by the same incentives: the need to curry favor with the politically influential and the desire to keep sweet the Wall Street elite.
And here’s the most incredible thing of all: 18 months into the most spectacular man-made financial calamity in modern experience, nothing has been done to change that, or any of the other bad incentives that led us here in the first place.
SAY what you will about our government’s approach to the financial crisis, you cannot accuse it of wasting its energy being consistent or trying to win over the masses. In the past year there have been at least seven different bailouts, and six different strategies. And none of them seem to have pleased anyone except a handful of financiers.
When Bear Stearns failed, the government induced JPMorgan Chase to buy it by offering a knockdown price and guaranteeing Bear Stearns’s shakiest assets. Bear Stearns bondholders were made whole and its stockholders lost most of their money.
Then came the collapse of the government-sponsored entities, Fannie Mae and Freddie Mac, both promptly nationalized. Management was replaced, shareholders badly diluted, creditors left intact but with some uncertainty. Next came Lehman Brothers, which was, of course, allowed to go bankrupt. At first, the Treasury and the Federal Reserve claimed they had allowed Lehman to fail in order to signal that recklessly managed Wall Street firms did not all come with government guarantees; but then, when chaos ensued, and people started saying that letting Lehman fail was a dumb thing to have done, they changed their story and claimed they lacked the legal authority to rescue the firm.
But then a few days later A.I.G. failed, or tried to, yet was given the gift of life with enormous government loans. Washington Mutual and Wachovia promptly followed: the first was unceremoniously seized by the Treasury, wiping out both its creditors and shareholders; the second was batted around for a bit. Initially, the Treasury tried to persuade Citigroup to buy it — again at a knockdown price and with a guarantee of the bad assets. (The Bear Stearns model.) Eventually, Wachovia went to Wells Fargo, after the Internal Revenue Service jumped in and sweetened the pot with a tax subsidy.
In the middle of all this, Treasury Secretary Henry M. Paulson Jr. persuaded Congress that he needed $700 billion to buy distressed assets from banks — telling the senators and representatives that if they didn’t give him the money the stock market would collapse. Once handed the money, he abandoned his promised strategy, and instead of buying assets at market prices, began to overpay for preferred stocks in the banks themselves. Which is to say that he essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival. The stock market fell anyway.
It’s hard to know what Mr. Paulson was thinking as he never really had to explain himself, at least not in public. But the general idea appears to be that if you give the banks capital they will in turn use it to make loans in order to stimulate the economy. Never mind that if you want banks to make smart, prudent loans, you probably shouldn’t give money to bankers who sunk themselves by making a lot of stupid, imprudent ones. If you want banks to re-lend the money, you need to provide them not with preferred stock, which is essentially a loan, but with tangible common equity — so that they might write off their losses, resolve their troubled assets and then begin to make new loans, something they won’t be able to do until they’re confident in their own balance sheets. But as it happened, the banks took the taxpayer money and just sat on it.
Continued at "How to Repair a Broken Financial World."
Michael Lewis, a contributing editor at Vanity Fair and the author of “Liar’s Poker,” is writing a book about the collapse of Wall Street. David Einhorn is the president of Greenlight Capital, a hedge fund, and the author of “Fooling Some of the People All of the Time.” Investment accounts managed by Greenlight may have a position (long or short) in the securities discussed in this article.
26 March 2007
Bond insurers and rating agencies in bed
Short-Seller Fires Torpedo at Biggest Bond Insurer: Joe Mysak
By Joe Mysak
March 23 (Bloomberg) -- If you want to piece together the sad recent history of MBIA Inc., the biggest municipal bond insurer, you could go through articles, sift through disclosure documents, attempt to gain access to transcripts of board meetings.
Or you could read through a 32-page letter written by William Ackman of Pershing Square Capital Management in New York.
The letter, a copy of which was obtained this week by Bloomberg News, is dated March 2 and was sent to John Siffert of Lankler Siffert & Wohl.
Siffert is a lawyer who was hired by MBIA Inc. at the behest of regulators after the firm settled a federal fraud investigation in January. He is looking into how the company does business.
The letter doesn't make for cheery reading, if you are an MBIA shareholder or if you own bonds insured by the firm. In fact, it reads a lot like an indictment, with prescriptive remedies including axing management, making them give back their bonuses and installing an independent board of directors.
Ackman has been a bear on MBIA stock for years, and in the letter says he expects ``having a net short position'' in MBIA Holdings, which is the insurer's parent, ``for the foreseeable future.'' That is, he's betting that MBIA stock goes down.
Happy Days
If you have been following the story at all, and you probably have if you either own the company's shares or some of the almost $1 trillion in bonds it has insured, you probably thought that all of its troubles were behind it.
That was certainly the opinion of investors and analysts contacted after the firm paid $75 million in January to conclude the federal inquiry into the securities and accounting fraud regulators said MBIA engaged in to conceal some stiff losses, the result of a hospital bond default. MBIA neither admitted nor denied wrongdoing.
Not so, says Ackman. ``We believe that there are a substantial number of additional troubled exposures at MBIA Insurance that are not properly accounted for, thereby giving the NYSID and members of the investment and analyst community a false sense of MBIA Insurance's capital adequacy,'' he writes.
NYSID is the New York State Insurance Department.
Ackman wants the Armonk, New York-based MBIA Insurance to hire an independent consultant to look at what the company has insured as well as its reserves and capital.
Conflicts of Interest
And then there's this little bombshell.
``While MBIA might claim that the ratings agencies effectively serve this function, we believe that the rating agencies have actual and perceived conflicts of interest in that MBIA Insurance is effectively one of the largest customers (if not the single largest customer) of Moody's, Standard & Poor's and Fitch as one of the largest public finance guarantors and structured finance issuers in the world.''
The rating companies regularly are paid by MBIA to evaluate the bonds it insures. They are the ones that determine the firm's so-called claims-paying ability. If you want to be a big-time municipal bond insurer, you want this to be AAA.
But wait a minute, as they say on late-night television: That's not all!
``Over the coming weeks and months we anticipate providing you with additional analysis of Holdings' other business practices that fall within the broader scope of your investigation,'' Ackman writes.
So, yes, it seems there's more.
Sleep Insurance
The Ackman letter was featured in a story on Bloomberg News on Wednesday. Predictably enough, nobody wanted to talk about it. But it doesn't look like Ackman is going away.
What a mess. Bond insurance didn't start this way. The insurers were supposed to underwrite business to a famous ``zero- loss standard,'' as they called it. That is, they never really expected to pay a claim. Can you imagine? The stuff they insured -- state and local bonds -- hardly ever defaulted.
There was a lot of resistance to using this new product when it was introduced back in the 1970s. Bond insurance? Who needed such a thing? Who would want it?
Well, a lot of people, it eventually turned out. Issuers liked it because it put a triple-A rating on their bonds, which meant they wouldn't have to pay as much to borrow. Investors liked it because even if the unimaginable happened and an issuer failed to make its debt service payment, they would still receive timely repayment of principal and interest. More than half of the municipal bonds that are sold every year are now insured.
The model works, until the insurers start looking for profits in other businesses and riskier credits. And now comes a great unraveling.
Bond insurance used to be known as investor's sleep insurance. How quaint.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
By Joe Mysak
March 23 (Bloomberg) -- If you want to piece together the sad recent history of MBIA Inc., the biggest municipal bond insurer, you could go through articles, sift through disclosure documents, attempt to gain access to transcripts of board meetings.
Or you could read through a 32-page letter written by William Ackman of Pershing Square Capital Management in New York.
The letter, a copy of which was obtained this week by Bloomberg News, is dated March 2 and was sent to John Siffert of Lankler Siffert & Wohl.
Siffert is a lawyer who was hired by MBIA Inc. at the behest of regulators after the firm settled a federal fraud investigation in January. He is looking into how the company does business.
The letter doesn't make for cheery reading, if you are an MBIA shareholder or if you own bonds insured by the firm. In fact, it reads a lot like an indictment, with prescriptive remedies including axing management, making them give back their bonuses and installing an independent board of directors.
Ackman has been a bear on MBIA stock for years, and in the letter says he expects ``having a net short position'' in MBIA Holdings, which is the insurer's parent, ``for the foreseeable future.'' That is, he's betting that MBIA stock goes down.
Happy Days
If you have been following the story at all, and you probably have if you either own the company's shares or some of the almost $1 trillion in bonds it has insured, you probably thought that all of its troubles were behind it.
That was certainly the opinion of investors and analysts contacted after the firm paid $75 million in January to conclude the federal inquiry into the securities and accounting fraud regulators said MBIA engaged in to conceal some stiff losses, the result of a hospital bond default. MBIA neither admitted nor denied wrongdoing.
Not so, says Ackman. ``We believe that there are a substantial number of additional troubled exposures at MBIA Insurance that are not properly accounted for, thereby giving the NYSID and members of the investment and analyst community a false sense of MBIA Insurance's capital adequacy,'' he writes.
NYSID is the New York State Insurance Department.
Ackman wants the Armonk, New York-based MBIA Insurance to hire an independent consultant to look at what the company has insured as well as its reserves and capital.
Conflicts of Interest
And then there's this little bombshell.
``While MBIA might claim that the ratings agencies effectively serve this function, we believe that the rating agencies have actual and perceived conflicts of interest in that MBIA Insurance is effectively one of the largest customers (if not the single largest customer) of Moody's, Standard & Poor's and Fitch as one of the largest public finance guarantors and structured finance issuers in the world.''
The rating companies regularly are paid by MBIA to evaluate the bonds it insures. They are the ones that determine the firm's so-called claims-paying ability. If you want to be a big-time municipal bond insurer, you want this to be AAA.
But wait a minute, as they say on late-night television: That's not all!
``Over the coming weeks and months we anticipate providing you with additional analysis of Holdings' other business practices that fall within the broader scope of your investigation,'' Ackman writes.
So, yes, it seems there's more.
Sleep Insurance
The Ackman letter was featured in a story on Bloomberg News on Wednesday. Predictably enough, nobody wanted to talk about it. But it doesn't look like Ackman is going away.
What a mess. Bond insurance didn't start this way. The insurers were supposed to underwrite business to a famous ``zero- loss standard,'' as they called it. That is, they never really expected to pay a claim. Can you imagine? The stuff they insured -- state and local bonds -- hardly ever defaulted.
There was a lot of resistance to using this new product when it was introduced back in the 1970s. Bond insurance? Who needed such a thing? Who would want it?
Well, a lot of people, it eventually turned out. Issuers liked it because it put a triple-A rating on their bonds, which meant they wouldn't have to pay as much to borrow. Investors liked it because even if the unimaginable happened and an issuer failed to make its debt service payment, they would still receive timely repayment of principal and interest. More than half of the municipal bonds that are sold every year are now insured.
The model works, until the insurers start looking for profits in other businesses and riskier credits. And now comes a great unraveling.
Bond insurance used to be known as investor's sleep insurance. How quaint.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
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