Ambac: More Smoke and Mirrors?

As the slow-motion train wreck in our financial system continues to unfold, there are going to be plenty of ill-conceived rescue attempts and dubious turnaround plans, as well as propagandizing, dissembling and scheming by banks, regulators and politicians. This is all happening in an effort to try and buy time or to figure out how the losses can be dumped onto the lap of some patsy (e.g., the taxpayer).

Given that, it makes sense to avoid acting like an equity investor and swallowing - hook, line and sinker - the alleged good news that will be constantly reported in the press or streaming across news tickers on CNBC, and elsewhere. While it is nice to think that this crisis could be resolved by those individuals and institutions that played a major role in creating the problem in the first place, it is not going to happen. Only time, trillions of dollars of losses, a substantial economic downturn, and a broad acceptance of today's harsh, new realities will accomplish that.

One way to avoid getting caught up in the fantasy world of light-at-the-end-of-the-tunnel Pollyanaism is to stay attuned to commentators who have been consistently ahead of the curve, and who have not been afraid to call it like they see it, however far outside of the mainstream their views might seem. One individual who falls into this camp, who I've mentioned and recommended a number of times before, is Yves Smith, publisher of the must-read Naked Capitalism blog.

In "Monoline Death Watch: A 'Bad Insurer/Worse Insurer' Split?" Yves offers up some sobering commentary on the so-called breakthrough that's apparently got the financial world in a bullish tizzy.

The market is willing to treat thin gruel as nourishment. We saw an impressive 250 point rally in the Dow on Friday and an over 400 point gain in the Nikkei based on the improving odds of a rescue of troubled number two bond guarantor Ambac (ABK).

But what is this salvage operation, exactly? The Wall Street Journal gives us some insight into the smoke and mirrors:

Ambac plans to raise $2.5 billion in a rights issue, in which shares are offered to existing shareholders at a discount to the market price, according to the people familiar with the matter. The bank group, which includes Citigroup Inc., UBS AG, Royal Bank of Scotland PLC and Wachovia Corp., would likely "backstop" the issue, meaning they would commit to buying up any unsold shares.

A rights offering with a mere backstop? ...

Comments

[CWall:]

What do you want your readers to think from your rather abrupt ending? "A rights offering with a mere backstop?" That backstop is all important as it guarantees the full $2.5 million is subscribed. It appears to be enough new equity to preserve the all important AAA rating... for now. Which means premiums on the existing book will continue to be paid which means the company stays around. If we must use the word, it is "merely" the difference between life and death.

The issue now is what is the future for the equity? How do you value a no growth company that is effectively in workout mode? You give it a big discount to its net asset value. And no one really knows what NAV is until the dust on the CDO's settle. But here is a hint: the ABX index which tracks the value of CDO's currently prices them at $0.64 on the dollar. For triple A rated paper. Shave 36% off the value of their roughly $160 billion of CDO's and the shareholder's equity is gone.

2008 Feb 26 01:03 PM

[caramba:]

CSW, I agree with you except that the ABX index is nothing else than ... an index, with no undelying asset. For me the big lie is that index is that it represents only investors mood. If you have big money, you can push it up or down and FORCE banks and insurance companies to make reserves that should not exist. This financial game went too far at the wrong time for sure

2008 Feb 26 05:58 PM

[john haskell:]

Ay Caramba! Why then did MER take a 1/3 writedown on their AAA rated CDO paper? Why are SIV's around the world being put into runoff? Why did a recent WaMu securitization with 92% of the pool rated AAA have 15% defaults/foreclosures within 12 months of the securitization? Because these assets are not "AAA" any more than Ambac itself.

Some of us remember Enron. Other members of the investment community apparently need to be re-taught these lessons every 5 years or so.

2008 Feb 27 04:57 PM

[caramba:]

1st there is a liquidity problem. SIV where a disaster in the making. financed by short term paper.
Then ML writedown, among others was forced by "mark to market rules" that didn't existed in the past. The ABX index has no real underlying assets. I do not deny the excess and bad paper, I just want to mention that due to the ABX index and other new rules, this crisis has been made worst. Most paper wote down are still paying their coupon. the real loss are when you have to sell. The worst positiioned are the SIV holders that don't have the capital to carry the paper on their balance sheet and are forced to liquidate. I bet you that in a year or 2 bank will recognize gains on these papers.

2008 Feb 27 09:05 PM

[vodka_tonic:]

caramba you are right a liquidity crisis is indeed overly devaluing CDO paper. but, as john above is also saying, a lot of this paper is actually worth much less due to the current housing market.
ambac is just treading water and the housing market IMHO is gonna get worse. i would not invest in it at any price.

2008 Feb 28 12:42 AM