Today’s Trading Is About The Bond Insurers
“The upshot of this is that capital needed to stay triple-A at S&P will likely rise substantially from the levels laid out less than one month ago.”
– David Havens (subscription required), analyst UBS Securities
It took me a while today to figure out why the market was selling off. Merrill’s big writeoff was no surprise to anybody and that can’t explain today’s selloff. Bernanke’s testimony was nothing new.
What it is really about is the fact that S&P on Tuesday night announced revised assumptions about the course of the housing meltdown and its effect on mortgage backed securities and that it is reviewing its ratings on the bond insurers in light of these new assumptions.
Last night (Wednesday), Moody’s put Ambac (ABK) on watch for possible downgrade (“Ambac’s Ratings Under Review For Downgrade” (subscription required – free), Moody’s, Wednesday January 16, 2008).
Just about a half an hour ago, S&P released their new projected losses for the bond insurance industry which came in about 20% higher than their review from last month (“Standard & Poor’s Updates Results Of Its Bond Insurance Stress Test For Revised Assumptions” (subscription required – free), Thu 1/17, 3:00pm EST).
But nobody cares about the bond insurers. They’re small companies and they’re dead meat.
The real concern is the wider implications because financial firms have hedged their mortgage backed securities exposure by buying insurance in the form of derivatives (CDSs) that are backed by the bond insurers. If the bond insurers go under, these financial firms can’t profit from their CDS hedge positions (for example, see CNBC NYSE floor reporter Bob Pisani’s blog post “Weak Markets: Bernanke Not Total Reason (Hedged Exposure)”).
And that’s the real factor driving today’s massive selloff.