Our nation's largest bond insurers are collapsing as we speak, but Wall Street's leading rating agencies are covering it up while regulators look the other way.Just last week, Ambac Financial Group, the parent of the second-largest bond insurer, shocked analysts with first-quarter losses of $1.66 billion — on top of $3.64 billion in the previous six months.
And the underlying facts denote a company in a death spiral:
Even excluding non-recurring items, Ambac's losses were $6.93 per share, more than quadruple the losses that Wall Street expected.
Ambac's writedowns of bad collaterized debt obligations (CDOs) and mortgage-backed securities were massive — $5.2 billion.
Its revenues from its credit insurance plummeted by 87%.
Its new policy business plunged to virtually zero.
The net worth of its bond insurance unit, Ambac Assurance, fell below the minimum required to maintain a $400 million credit line — cash the company may need in a pinch.
The company's shares, which had already lost 93% of their value last year, promptly tumbled another 43% on the news.
And perhaps most telling of all, the cost of credit swaps on the company — derivatives designed to insure Ambac's guaranteed bonds against default — went through the roof. Just to insure investors for $10 million for five years, it would now cost $1.1 million in upfront premiums plus an additional $500,000 per year. Total cost: a whopping $3.6 million. (Imagine a $10 million life insurance policy costing a man $3.6 million in premiums! Not exactly a vote of confidence in his life expectancy.)
With all this happening — devastating losses, its entire business model on the rocks, a cash squeeze and even questions being raised about its future solvency — you'd expect Wall Street's rating agencies to immediately announce deep downgrades in one fell swoop.
But they did precisely the opposite. On Wednesday, Standard & Poor's announced that Ambac's triple-A is "solid," and on Thursday, Moody's also reaffirmed its Aaa rating of the company.
Meanwhile, New York insurance commissioners, while saying they're trying to protect the public, have not only been endorsing the inflated ratings, but actively pleading with the rating agencies not to issue potentially fatal downgrades. Even as recently as last week, New York insurance superintendent Eric Dinallo echoed the mantra of the agencies that the bond insurers are "within the stress scenarios."
How does the CEO of an S&P or a Moody's look himself in the bathroom mirror each morning? You'd have to have a Ph.D. in both psychology and finance to figure it out. But let me at least point out some of the symptoms of the psychosis:
First, while doing absolutely nothing to alter the ratings, they find all kinds of alternate devices to communicate to the world that they're not dumb, that they know the companies are, indeed, in trouble.
They put the company's rating on "negative outlook," which is supposed to send the message that, although they may not be doing anything, they're at least "thinking about it."
Or they try to sound like rational analysts by actually saying some pretty negative things about the company.
In fact, Reuters reports that the rating agencies have explicitly expressed concern that Ambac "did not have enough capital to cover both a bond default and the crumbling of the securities relying on mortgages." And even S&P's own insurance analyst, Cathy Seifert, said: "The risk is that if [Ambac] can't regain the confidence of the marketplace. Then it's game over."
The rating agencies seem to attribute great import to their commentary and conditional statements surrounding their triple-A ratings. But they're apparently not important enough to include with bond offerings to investors, who typically see only the three letters: S&P's AAA or Moody's Aaa.
Second, the CEOs of the rating agencies rationalize that their deceit, no matter how obvious and egregious, is actually "a public service" in disguise.
They know that the entire business model of bond insurers like Ambac is predicated on their triple-A ratings.
They know that if they take away the triple-As from the bond insurers, they could destroy their business and even possibly doom them to failure.
They know that the bond insurers cover hundreds of thousands of municipal and state governments. So if the bond insurers went under, the entire market for municipal bonds would collapse, threatening the finances of hundreds of thousands of local and state governments throughout the nation.
And they also know that their own firms — the rating agencies themselves — derive a big chunk of their revenues by rating those same local governments. So if they downgrade the bond insurers, they are, in effect, threatening the future of their own business.
Result: While their own ratings analysts scream internally for immediate downgrades, the CEOs jury-rig the process, override the analysts' conclusions and force-feed the triple-A.
Needless to say, calling this a "public service" is a futile rationalization. The truth will come out no matter what and it's only a matter of time before the rating agencies must cave in to reality, downgrade the bond insurers, and finally face the day of reckoning they've tried so hard to postpone.
The only lasting consequence of the rating agencies' delay tactics is to allow time for more people to get trapped in bad investments and more local governments to borrow money they can't repay. End result: Bigger shock waves on Wall Street and more damage to our economy than it would have suffered otherwise.
