Tuesday, June 17, 2008

Monoline micturations

OK, so I've been reading what may well be an interesting scoop from the New York Times on the future of the bond insurers. It turns out that they have a huge amount of leverage over insurance regulators because if they become insolvent or are taken over, counterparties on their portfolio of credit default swaps could ask that these be repaid immediately. Or:

MBIA has written $137 billion in swaps, which are privately traded insurance contracts that let people bet on companies’ financial health. Most of these contracts stipulate that if MBIA’s bond insurance unit becomes insolvent or is taken over by state regulators, buyers can demand payment immediately.

This sounds pretty horrible, and I must confess I had always assumed that there were no circumstances under which a counterparty could accelerate on a credit default contract. But what's weird is that the Times could not persuade either the regulator or the monolines to acknowledge that this might be the case. Here's New York's regulator, Eric Dinallo, on the subject:

“It is a concern that possibly if one of the companies filed for rehabilitation or if we move to rehabilitate, the holders of the credit default swaps could move to get preferential treatment,” he said.

"Preferential treatment" is a long way from "all of their CDS comes due right away". Then we get closer to an acknowledgment from MBIA, although it's difficult to say whether they're being evasive and unwilling to discuss insolvency or suggesting that there's a very severe set of circumstances under which the CDS would come due.

The swaps’ acceleration clauses appear to be a factor in this bit of brinksmanship, although MBIA does not advertise their existence. In a presentation about its first-quarter results, for example, MBIA said its “insurance contracts are not subject to acceleration.”

Asked about this discrepancy, MBIA said the presentation language meant that holders of its swaps have no acceleration rights “as long as the company continues to operate in its current manner,” which it believes it will do.

“Fortunately, for us it’s not something that we have to be concerned about,” said Greg Diamond, director of investor relations for the company.

I'm a huge water-carrier for the monolines, and might be making too much of a slight gap in the Times' ability to get the terms of the CDS contracts on record. Or I might be getting to excited over a situation that is, for now, hypothetical. It's interesting, too, to see an article on the monolines that doesn't just approach it from the point of view of their ratings. But the article has a slightly peculiar aftertaste.

[UPDATE: It occurred to me as I was going to sleep - what if the Times had confused credit default swaps written against MBIA, all of which would definitely be accelerated in the event of an insolvency, and CDS written by MBIA, not all of which is distressed, and would only be called if the underlying credit defaulted?]


At 8:43 AM, Anonymous Cahagnes said...


I'm virtually certain that the NYT got this one wrong. It may be that the NYT has confused CDSs on MBIA (as Reference Entity) with CDS written by MBIA (as protection seller), as you suggest in your update. It's also possible that the NYT has mixed up the Calculation (or notional) Amount of a CDS on the one hand (i.e. the max amount "insured") and its market value on the other. It's the latter, not the former, that MBIA would have to pay to its counterparty upon insolvency (of MBIA) and close-out if its counterparty is in-the-money.

Where the NYT writes that "MBIA has written $137 billion in swaps, this seems to refer to the total notional amount of outstanding CDSs. If that is the case, it's misleading to suggest, as the NYT does, that MBIA could be liable to pay that amount, or anything even remotely close to it, upon insolvency or take-over by the regulators.


Post a Comment

<< Home