Hope Springs Eternal - But For How Long?

 |  Includes: DIA, QQQ, SPY
by: Michael Panzner

All sorts of dead cats, including the shares of homebuilders, banks and a variety of insolvent financial companies, staged vicious bounces on Wednesday, aided by panic short-covering and the latest in what promises to be a never-ending series of failed attempts to forestall the inevitable.

Mark my words: Wednesday's euphoria over attempts by regulators in one of the financial world's most loosely monitored and industry-friendly regimes to resolve one aspect of a very large mess will prove short-lived. The results will be just as illusory as they were following reports of a Treasury-orchestrated SIV rescue effort, the Federal Reserve's unusually aggressive credit-market interventions, and Washington's plan to bail out ailing homeowners (and their lenders, of course).

Still, for anyone who's never traded during a bear market, it's worth keeping in mind that now might not be the time to play things from an overly aggressive tack. In my experience, explosive, non-linear moves are the norm in this type of environment, which makes sense given that fear, rather than greed, is the primary motivating emotion. And like I've noted on many occasions previously, no market moves in a straight line, even if it is eventually headed towards zero.

That said, the kinds of spikes like we saw on Wednesday make me wary that we might be looking at the set-up for an eventual crash. While it is foolhardy to predict such an event, given how infrequently they occur, rallies driven by false hopes and short-covering where there is little evidence of wholesale capitulation beforehand (e.g., investors puking positions into a dark abyss) tend to leave something of a vacuum not far under current prices.

Anyway, in "Banks, New York Regulator Meet on Bond Insurer Rescue," Bloomberg details Wednesday's allegedly earth-shattering development.

New York State's insurance regulators met today with U.S. banks to discuss raising new capital for bond insurers, said a department spokesman.

Talks in New York with the unnamed banks are part of Insurance Superintendent Eric Dinallo's effort to stabilize the bond guarantors and bolster the market's finances, said agency spokesman Andrew Mais in an interview. Insurers MBIA Inc. gained 33 percent in New York trading and Ambac Financial Group Inc. soared 72 percent.

New capital may help preserve the top credit ratings for the bond guarantors such as MBIA, the industry's largest, and halt any erosion of investor confidence in the $2.4 trillion of assets they guarantee. Ambac, MBIA's biggest rival, lost its AAA grade from Fitch Ratings this month on concerns that losses tied to subprime mortgages may increase.

"The market is obviously viewing it as positive news," said Kathleen Shanley, an analyst with bond research firm Gimme Credit LLC in Chicago. "Shareholders and holding company creditors should keep in mind, however, that the insurance department's primary mandate is to protect policyholders, not to boost the share price."

Federal Reserve Bank of New York President Timothy Geithner has taken a central role among federal regulators monitoring the financial health of bond insurers since October, according to an official familiar with the matter. Geithner has been speaking frequently to bank executives who do business with the insurers and requesting government data on Wall Street's involvement, said the official, who wasn't authorized to speak publicly. New York Fed officials didn't participate in today's meeting.

Cash Infusion

The infusion may be as much as $15 billion, the Financial Times reported. MBIA rose $4.08 to $16.61 in New York Stock Exchange composite trading, while Ambac added $5.73 to $13.70.

News of the meeting helped spur a rally in U.S. stocks, which slid Jan. 18 after Fitch lowered the rating of Ambac. The Standard & Poor's 500 Index halted a five-day slide, rising 2.1 percent to 1,338.60 after losing as much as 3 percent earlier.

"Clearly the market likes it," said Gregory Peters, credit strategist at Morgan Stanley in New York. "But it's not an easy situation to fix. The intent is good but we need the details; the details matter."

Moody's Investors Service and Standard & Poor's are reviewing Ambac and MBIA, both based in New York state, for possible downgrades. Insured municipal bonds usually carry the debt rating of the insurer rather than the underlying debt.

Falling Values

Downgrades may force sales by investors who are required to hold only the highest-rated bonds and cut profit for banks that have already posted more than $130 billion of writedowns and credit losses tied to the falling value of mortgage securities.

Ambac and MBIA have suffered losses because of guarantees they sold for structured investments such as collateralized debt obligations backed by mortgages. The industry collectively guaranteed $127 billion of CDOs linked to mortgages that were given to borrowers with poor credit.

The securities have plunged in value as defaults by borrowers soared to a record in the third quarter of last year, according to the Mortgage Bankers Association.

A message for Ambac spokesman Peter Poillon wasn't immediately returned. An e-mail message sent to Michael Sitrick, spokesman for MBIA, wasn't immediately returned.

Paulson's Role

Treasury Secretary Henry Paulson this week said he's monitoring the situation, although he declined to characterize the role his department is playing.

"We obviously have been looking at the monoline insurers carefully for some time now and we're actively engaged in watching that sector and talking with other policy makers about that sector," Paulson said Jan. 22, when asked after a speech in Washington.

Ajit Jain, who heads a new bond insurer started last month by Warren Buffett's Berkshire Hathaway Inc. to compete with MBIA, Ambac and others, said in a Jan. 9 interview that Berkshire was "looking at ways to support the existing insurers in terms of reinsurance and capital."

Jain, who also heads up the units that sell coverage for catastrophes and other large risks, declined to comment today.

Credit-default swaps tied to the bonds of MBIA plunged to 825 basis points a year, down from 22 percent upfront and 500 basis points a year yesterday, according to CMA Datavision. That means the cost to protect $10 million in MBIA bonds for five years fell to $825,000 a year from $2.2 million upfront and $500,000 annually yesterday. Contracts on Ambac fell to 900 basis points from 22 percent upfront and 500 basis points a year, CMA prices show.