More on TARP and the Insurance Industry

Last week, there were two stories about insurance companies possibly coming under TARP. One was about life insurers, specifically MetLife (MET); the other was about bond insurers, to include Ambac (ABK) and possibly MBIA (MBI).

My take on these two stories:

Life Insurance – the story was replicated by a number of news services, relying on the usual “sources familiar with the matter.” After reading the various versions, what I saw was MetLife (MET), which is a financial holding company and a bank holding company (because it owns a bank), trying to get itself included in the Capital Purchase Program designed for banks. Apparently there was some sympathy in Treasury toward this effort.

Other life insurers that are or may become capital-challenged were named as additional candidates for inclusion, which seemed to be dependent on having some connection, however remote, to banking. These included Prudential (PRU) and NY Life. Hartford Financial Group (HIG) was up on the story. Noting that AIG owns a bank, and that I own quite a bit of AIG, bought dirt cheap, I advocate including them in the program, rather than going through with the cruel and unusual 80% dilution imposed by Paulson. That was just a misunderstanding which could easily be corrected. AIG is subject to regulation by OTS (Office of Thrift Supervision), so why not call it a bank and do the bailout on more favorable terms?

To me, the significance of this story is that the capital plan is popular. It provides needed capital on reasonable terms. Basically, the climate of fear, and the merciless short-selling that accompanies any effort to raise capital, has cut many viable financial companies off from the capital market, and Treasury has stepped in to fill the void.

Bond Insurance – this story developed from interviews given separately by Mike Callen, at the time CEO of Ambac, Eric Dinallo, Superintendent of the New York State Insurance Department, and Sean Dilweg, Commissioner of Insurance in Wisconsin. The facts behind it are that a meeting was held in Dinallo's office, attended by Dilweg and representatives of a number of insurance companies, to develop some ideas on a bailout program to propose to Treasury.

The versions given by Callen and Dilweg differed on one significant point: Callen didn't see a bailout as including the Treasury taking an equity stake, but Dilweg said that was on the table. Not long after, Ambac announced that Callen would retain his duties as Chairman of the Board but would be replaced as CEO by David Wallis, previously head of risk management.

As an aside, Callen was critical of the rating agencies in a recent interview he had with Margaret Popper on Bloomberg. He likened their rating committees to bands of hooded monks, armed with AK47s, remorseless executioners. I liked the simile and used it in a humorous blog which attracted very little readership or comment. I doubt that Moody's (MCO) and S&P (MHP) found it quite as amusing as I did.

Perhaps David Wallis, who is a numbers guy and doesn't have any publicly stated opinion on an equity position for Treasury, would also be able to talk more productively with Moody's (or S&P, as the case might be) than a man who has likened them to hooded executioners. Or would be perceived as more amenable to reality in discussing the terms of a bailout with Treasury. Just a thought.

I have some grounds for hope that Ambac will not be hopelessly diluted; Dilweg has stated that the bond insurers have plenty of capital, it just gets sucked out as collateral. That would refer to the situation in Ambac's asset management business, where a downgrade from Moody's will precipitate a liquidity crisis.

Dinallo, who is one of the most level-headed and impartial players in this ongoing drama, said in the course of an interview on CNBC that he felt the bond insurers should be included in the bailout. He mentioned a total capital requirement of 10 billion and remarked that you get a lot of bang for the buck by stabilizing the bond insurers' ratings, since that would fix everything they insure, more than a trillion worth of bonds. He added a 20 billion figure as an afterthought: it seemed to me he was looking at the 250 billion given to banks and thinking how small the bond insurance problem is by comparison. You had to be listening, but I heard 10 billion, with the 20 billion in no way stressed as really needed.

As a practical matter, the long term outlook for the economy and the bond market has dimmed substantially in the past month, so scenarios could change and with that expected losses would increase. I hate to say this, but the rating agencies, with Treasury as a potential source of funds, are likely to demand more capital in order to cover their backsides. Moody's recently testified to Congress that there is a mis-perception that their ratings rely on mathematical computations.

Translation: they won't let their own rating models deter them from their downgrade rampage.

Sean Egan, CEO of Egan-Jones, testifying at the House Oversight Committee hearings on Credit Rating Agencies, accused the agencies of covering up ABK and MBI, which he characterized as nearly insolvent. He mouthed a back of the envelope estimate of 200 billion of capital needed. His math: they both have 30 billion of CDO exposure, give that a 30% haircut and triple it. That is more like a cocktail napkin type estimate than a back of the envelope. I dislike and distrust that man; I see him as motivated by the desire to undermine what little is left of the credit rating system, for his own gain. He regards MBI and ABK as the competition and took advantage of the opportunity to do a number on them.

In any event, a meeting was held at Dinallo's office, to develop ideas on what the proper structure of a bailout plan for the bond insurance industry would be. Discussions are expected to continue. MBIA was not listed as in attendance, although one news story noted that their offices are in New York. Presumably sources familiar with the matter at MBIA were less forthcoming than those at Treasury.

My interpretation of this situation is that the Moody's executioners, black hoods, masks, AK47s and all, are holding their fire while Dinallo works with the bond insurers to see if they can come up with something constructive to propose to Treasury. A plan that relies on the state regulators to determine who was still strong enough to participate and how the capital should be allocated, and includes a preferred stock and warrants structure, like what was done for the banks, would be very good for the bond industry and the credit market. It would also be very good for me because I am long both Ambac and MBIA.

MBIA's role is harder to figure, but given that they have completed a reinsurance transaction whereby they took over FGIC's municipal book, at Dinallo's request, they are part of the solution. As such, they would receive enough capital to stabilize their rating. MBIA has described itself as “a business that is not dependent on capital markets for funding.” I don't know what that means, but I doubt it means that Treasury can confiscate my interests like they did at AIG.

It's fun to go over the situation and see various reassuring possibilities. But Paulson so far has been totally unpredictable, wiping out shareholders mercilessly, until he came to the CPP for banks, who get a very nice deal, along with some guidance on how they should spend the money, like do takeovers. It still leaves me in the position of owning some stocks where I can be wiped out by the capricious abuse of regulatory discretion. Give me a small rally in ABK and I'm out of there. MBIA I plan to hold on through – it is less vulnerable.

Disclosure: Author is long shares of MBI and AIG, long calls on ABK, short puts on HIG

Comments

[apppro:]

A paln that WORKS for allof us:

Take a small amount of that ‘Rescue plan’ = maybe 20 billion and buy back the CDO’s of the muni bond insurers (Ambac, MBIA) – RIGHT NOW! Recapitalize them, as Sec. Dinallo of NY wanted to do 10 months ago.

Make sure the ratings agencies then immediately upgrade the ratings back to AAA, which they said would happen. Then come up with a universal set of rules that those agencies must play by.

Have the FED give an implicit guarantee to ANY NEW insurance policies written on the bonds. Basically guarantees the bond’s triple A, not the policy or the company just the bond until new triple A can be found. Doesn’t cost a nickel.

Have the Fed could kick in an incentive for any bonds issued for Capital Projects to help with employment and infrastructure.
NOW the municipalities can issue bonds and BUILD.. BUILD.. BUILD. Puts people back to work. Pays our bills, etc. We need the bond insurers restored back to normal and we need it now. Solves ALL the issues at little or less costs.

2008 Oct 27 07:42 AM

[CrossProfit_:]

Nice article.

As an aside, there are two new competitors on the block, Buffett and Citadil. If ABK's future is the reason for your 'spike and leave' conclusion, it may be premature to make such a call.

CrossProfit

2008 Oct 27 08:01 AM

[applesauce:]

Take the trillion or so and invest it in Brazil, that will solve th energy issue and provide long term growth for the tax payer instead of throwing it down the rat hole. Oil, grain, and a work force not afraid to work, kinda of like America fifty years ago.

2008 Oct 27 08:59 AM

[CT Programmer:]

Remember how California was saying they didn't need bond insurance and how they were going to start their own line? That was before their Gubernator went begging for cash from the Treasury. By almost all estimates I've seen put out there (except for the shorts), MBIA is highly capitalized. And they've got a CEO who has proven that he's actually WORTH the money they pay him. He is savvy and quick on his feet. Sure they've been downgraded and that triggered some losses, but they've calculated all that in. They have been very conservative. I don't want to take any blame away from their increase in riskier practices, or from the rating agencies for not properly analyzing their (or anyone's) risk, but people started acting like these bond insurers were worthless business models and needed to go under, and that their struggling was indicative of that, yet we now know that they were the first red flag of a systemic financial crisis. Yet, given all that, I don't think MBIA should take any money from the Feds. I don't think they really need to. Sure, it would boost them to AAA overnight, but I think damage has been done to the credibility of bond insurance as a whole, and what it will take to cure that is time, not a quick cash infusion. If MBIA surfaces from all this without Fed money, they gain back more credibility than if they take the money. I agree with appro that an FDR approach of an increase in government spending (especially at the state or local level) could help us dig out of a recession, but I also doubt that will happen. Towns and municipalities are now starting to tighten their belts as their tax bases erode. That means less projects, not more. I don't think lowering the costs of bond insurance (and thus the cost of projects) will cause more projects to come about. I think the projects are being shelved at any cost. You would have to have targeted Federal injections at the local or state level to change that, and I haven't heard any kind of talk along those lines.

2008 Oct 27 09:11 AM

[Fulldeck:]

Can Dinallo take on Buffett?

For starters, here's Ambac's proposal to Treasury, presumably to be presented by Dinallo.

www.ambac.com/pdfs/Amb...

And as an owner of ABK debt (AKF/AKT), I hate to admit it, but these are the facts.

. Obama is more than likely to win the Presidency

. Warren Buffett is Obama's economic advisor

. Warren Buffett is no fan of Ambac-
www.iht.com/articles/2...

In fact, he started his own competing muni bond insurer-

en.wikipedia.org/wiki/...

. According to Gasparino's reportage on CNBC, the "re-insurance" part of the TARP would likely be months away.

. "Months away" puts us into Obama's presidency, or at least gives him significant say over TARP decisions while awaiting inauguration.

. Warren will have Barack's ear. Warren's Berkshire Hathaway Assurance would be relegated to an also-ran if Ambac's and MBIA's ratings were restored.

I also noticed that in the Congressional hearings with the NRSROs- (S&P, Moody's, and Fitch), Paul Sarbanes had a negative tone re helping the "monolines" after hearing Egan's testimony.

I think Ambac's proposal is a sound one, but I also think Dinallo will be facing a strong headwind.

All opinions appreciated.

2008 Oct 30 12:27 AM

[Tom Armistead:]

I agree that Ambac's plan would work, but I notice MBIA, which also published its response to the Treasury questions, was less enthusiastic about the guarantee program. Ambac sees the goal as stabilizing financial guarantor ratings, presumably at triple-A, while MBIA subsribes to the goal as stated in the legislation, which is stabilizing the system. MBIA thinks the Asset Purchase or Equity Purchase would be more effective in achieving the goal.

So I don't see the monoline positions as united. I'm sure Berkshire Hathaway was also asked to comment - what would Warren say? I don't know how the politics of this situation would work but if I were Paulson I would value Dinallo's input.

Being long MBI shares and long ABK calls, as well as holding some AKF, I would benefit the most if Treasury reinsured or provided excess coverage to MBI and ABK, which could increase their rating agency capital enough to stabilize ratings. That would get around the dilution issue of Treasury taking an equity position, and would work faster than asset purchases, which would take a while to influence the market.

Pauson likes stuff that works fast.

The more I think about it, the AKF looks better than the shares because it benefits from any intervention.

2008 Oct 30 07:32 AM

[James Wilson:]

MBI Director buying and selling the same amount of stock on the same day at the same price ????

Shorting the stock in his own company ????

2008 Nov 01 10:54 AM