Tuesday, November 20, 2007
Hell's Bells Ringing On Wall Street
The rumor is that ACA is trying to renegotiate its credit swaps. ACA filed a 10Q saying that its auditors say it cannot post the required collateral if its credit rating is downgraded:
As discussed in Note 16 to the condensed consolidated interim financial statements, on November 9, 2007 Standard & Poor’s Rating Services (“S&P”) placed its financial strength rating of ACA Financial Guaranty Corporation (“ACA FG”), a wholly owned subsidiary of the Company, on “CreditWatch with negative implications”. Should S&P ultimately downgrade ACA FG’s financial strength rating below “A-”, under the existing terms of the Company’s insured credit swap transactions, the company would be required to post collateral based on the fair value of the insured credit swaps as of the
date of posting. The failure to post collateral would be an event of default, resulting in a termination payment in an amount approximately equal to the collateral call. This termination payment would give rise to a claim under the related ACA FG insurance policy. Based on current fair values, neither the Company nor ACA Financial Guaranty would have the ability to post such collateral or make such termination payments.
Contrast its Q3 2007 call on November 16th! Here's an earlier article about the implications. This is total fear territory. It's hard to see how ACA could raise capital with a share price under $1.50. A Barron's article:
ACA has long been a convenient dumping ground in which major subprime securitizers like Bear Stearns (BSC), Citigroup (C), Merrill Lynch (MER) and some 25 other prominent dealers could pitch billions of dollars of risky obligations for modest premiums. That let them gussy up their balance sheets and shift any potential mark-to-market hits to ACA.ACA's GAAP loss in the third quarter was something like $29.00 a share.
If ACA Capital were to founder, more than $69 billion worth of CDOs, including the $25 billion in subprime paper, would come rumbling back to the Wall Street banks, and likely with heavy attendant losses.
That's why Wall Street has continued to do a brisk business with the beleaguered firm. In the third quarter, ACA insured some $7 billion of subprime collateralized-debt obligations. Even if the company survives for only another couple of quarters, that would stave off the recognition of billions of dollars of losses.
Freddie Mac took major losses on its guarantees (as of course Fannie did), and Freddie announced its losses along with an intention to raise capital. How can the securitization business survive without drastic changes? The answer is that it can't (auto debt losses and CC debt losses are rising as well), and the matter is so dire that (gasp) Street lawyers are losing their jobs, which of course follows layoff announcements in fixed income groups of financials. That is when the Street begins to panic - when it strikes home.
Of course, the UK banking problems aren't helping any. At this point, it's good to have cash on hand. You won't necessarily be able to clear many holdings for a while. Lord only knows what BofE is going to do, but it has its own problems with the same sorts of debt that are ripping up the pavement on Wall Street.
Update: Calculated Risk has a comment thread on ACA. From reading it I realized that many don't understand the significance, for which I apologize.
Securities are given a rating at the time they are first sold. No one would buy them without that rating, and for many investors, regulations require that securities must have a certain rating in order to be held. In some cases, the rating is boosted by insurance, a guarantee or a swap. If ACA cannot in fact meet its obligations, then those guarantees are worthless. This would cause a further ratings downgrade of those securities, which would cause investors and bagholders to have to mark their fair market value down or sell the darn things. Of course, if anyone sells that is going to push the fair market value even further down. Also, in the event the securities started to default, there would be no one to cover the losses.
ACA is currently rated A, which should tell you something right there. What the heck was anyone doing relying on an A-rated entity to provide insurance? Even the AAA rated ones are in severe difficulty.
The next step for a downgrade is A-. If ACA is downgraded below that, then all of this comes into play.
The really funny thing is that ACA probably has decent leverage. If it gets a renegotiation on the terms of its swap deals, the loss will be less to those who are holding those securities and CDOs. This fact alone points out the insanity of this form of "insurance". When your insurance company can basically make you renegotiate by posing the possibility of default, you don't have any insurance. Quite a problem for the fourth quarter financials, eh? Remember, those are the ones that have to be signed off on under the threat of criminal penalties.
I have a hard time believing that one can renegotiate these terms and continue to pretend that much real insurance exists on these juicy AB instruments. So frankly, I would think the game is up for these companies.
If you think this all sounds completely insane, you are a normal person. It is and it was.
It looks like the swaps may finally come out to play. I'm guessing it's going to get pretty confusing out there... especially once counter party risk becomes a believable concern.
This is the point I've been imagining. People may actually realize that just because they write down some numbers on paper and add them up to get $347 trillion (for interest rate derivatives) or $45 trillion (for credit derivatives).. this doesn't make the money actually exist.
I wonder how much global currency is actually in circulation? Best I can tell, in 2000.. there were ~571 billion US dollars in circulation. I'd guess we're easily past one trillion US dollars in circulation now. (Maybe it's more like 800 billion).
Either way, I'm guessing a whole lot of money is going to be printed in the next few years.
There's fluff globally. Extreme fluff.
yes.. that's why I wish there was an easy breezy source for and estimation of the total currency of all types in circulation.
Who even knows.. maybe we really have two trillion US dollars in circulation.. or maybe 3 trillion. (I wouldn't be surprised if the amounts are under-reported.)
I'd sure feel better thinking the system was only leveraged up to something under 20:1.. instead of something like 75:1 or 125:1.
Then don't downgrade their rating. Problem solved. See how easy?
I don't see where this ends. Could be we're headed for a hard reboot. I'm stocking up on canned goods.
DearieMe - heck, it wouldn't be so bad mislaying the personal data if they could just keep track of the bank equity! The EU and the UK injected very large sums of money into their zones this summer, and the UK is boiling up problems with several banks right now.
Edgar - I think to keep their franchise the agencies will have to downgrade ACA now. If you file saying you can't cover it if you have to, what does that say about your creditworthiness?
Anon - cash and carry! All the soothing words about "US" and "subprime" ignore the reality of the swaps and bad loans overseas. The problem is that this is truly a global economy.
Eli, MOM... everyone PUH-LEEZE don't push the panic button. There is PUH-LENTY of money in the system to satisfy those transaction demands...
The money just has to change hands really, really fast.
Problem solved with the help of the General Theory of [ECONOMIC] relativity.
A really BIG wind tunnel, and people with baskets of cash at either end?
Might have to add lead gloves to the Christmas wish list... Think they might have'm at Sharper Image too. They got everything power money handlers could ever want...
But essentially, isn't that ACA's bargaining point for its negotiations?
Possibly, but when there are a multitude of organizations who reckoned themselves "too big and important to fail" that all become dysfunctional at the same time then it confuses and overwhelms the PTB to the point that they throw up their hands in despair at the entire situation. In essence I was making light of their reaction to this mess so far, that is to claim there is no problem, or that the problems are contained, or to procrastinate in dealing with the problems, or to make matters worse by attempting to fix problems with the same methods that caused the problems in the first place. i.e. cheap credit caused problems? Throw more cheap credit at the problem! Lack of regulation & / or integrity caused problems? Try more shenanigans! This thinking will continue until it just can't any longer. That is why I make light of the situation we have now, because no way they can straighten out what is inherently crooked, not this time.
From Yves Smith, we learn that the ratings companies don't always give a fair market evaluation:
In early September, a senior Moody's executive....at a small private dinner....said, "Moody's would never lower the credit ratings of a financial guarantor, because that would put the guarantors out of business."
But seriously, with the advent of electronic banking, printing presses are obsolete.
Forget the wind tunnels, not enough paper, and the particle accelerators do too few electrons, all you need is a PC and an indefinite loop. In fact, since most of these do not have any paper representation, all that has to be done is wipe a hard drive.
Almost reminds me of those missing mortgages in those foreclosures actions.
In any case, the new clothes of the emperor, have been reviled.
The elephant under the rug in the living room is not going to go away.
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