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Stock markets gyrated from misery to euphoria when news broke that a proposed cash infusion into the monoline insurers, namely MBIA (MBI) and Ambac (ABK), was being sought by New York Superintendent of Insurance Eric Dinallo. At risk is an estimated $2.5 trillion worth of debt securities, issued with guarantees by the insurers, whose combined stock market value is less than $2.5 billion. Under the formula seriously floated, $5 billion would be infused immediately by banks who have the most to lose in a default, followed by an additional $10 billion follow-on capital, all to secure their AAA credit ratings. The plan being that injecting fresh reserve capital would shunt a domino effect from sell-offs required by holders who can either not hold less than top rated securities in their money market accounts, or whose statutory reserve capital would be at risk (banks, broker, and insurers). Dinallo’s plan echoed an earlier bailout call by Jochen Felsenheimer, head of Credit Derivatives at UniCredit, Spa in Munich who advocated that “monetary authorities or governments” should back a bailout or see the monoline industry fail.

This is incredulous on two counts: First, that insurers could guarantee thousands of billions of dollars worth of debt in exotic debt securities and anyone would think that they had a guarantee in the first place; and secondly, how a credible regulator, after the fact, can think that institutional investors understanding the enormity of the risk exposure and uncertainty of payoff they now face with micro-fractional reserve capital at a ratio estimated to be 250:1, would think such a plan would float or be viable! (The failed ACA Holdings (OTC:ACAH) which defaulted on $60 billion in credit swaps is required to add capital at a 35:1 ratio).

Indeed the facts are that the financial system has been hyper-leveraged with inflated value mortgage-back and derivative debt securities now not worth a 100 cents on the dollar. In fact, nobody knows what the value of the underlying collateral is, who owns what, or who is even solvent. The financial markets have seized up, creating such a risk adverse mood that investors are willing to accept 4% interest on a 30-year government-guaranteed bond, which likely guarantees them a negative return after inflation. The only credible solution is that losses must be realized, and any plan to patch the system with contrived value schemes is surely not to pass the smell test, just as the super-subprime fund plan did not. No, this is a market environment where investors smell blood and only a bloodletting will now suffice. The fools bought in the first round and now are all gone.

Source: Monoline Insurance Bailout: Where's the Justice in That?