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