Every business transaction revolves around trust. You have to trust that the person or company you do business with will fulfill their part of the deal. For investors, historically our trust in a corporation's financial condition was upheld by one of three credit rating agencies: Standard and Poor's, Fitch Ratings, or Moody's. These groups issued a rating for every company out there.
The ratings ranged from the highest, "AAA," to the lowest, "C" or "D." If a company was rated "AAA," the likelihood of it defaulting on its debt was extremely low. If it was rated "C" or "D," it was considered "junk" and about to default. Things worked great with this system until February 25, 2008, when the credit rating agencies did an incredible thing: they upheld MBIA's (MBI) and Ambac Financial's (ABK) "AAA" credit ratings.
MBIA and Ambac are bond insurers. Combined they guarantee $1.2 trillion worth of corporate and municipal bonds. If one of the bonds they cover defaults, MBIA or Ambac make sure the people who bought the bond get paid. And because MBIA and Ambac were rated "AAA," they could extend this rating to the bonds they insured.
The problem was that MBIA and Ambac insured a ton of bad mortgage debt during the housing bubble. They were like butchers who packaged rotten meat as gourmet cuts. By the end of 2007, things had begun to stink so badly that the two companies were in serious trouble. Since the beginning of 2007, MBIA had lost over 80% of its market value. The company had less than $6 billion in cash and was sitting on over $17 billion in debt. It had cut its dividend and needed $2 billion in capital just to stay in business.
Yet, in spite of all these problems, the credit rating agencies stated that MBIA was a "AAA" business: as safe to buy as Warren Buffett's Berkshire Hathaway or General Electric. They were lying. Seeing this and other coverups in the financial industry, I told readers of my newsletter International Wealth Advisory to sell short financial stocks. I knew that eventually the rating agencies would have to fess up and lower MBIA's and Ambac's ratings.
They finally did. Last Friday, the credit rating agencies lowered MBIA's and Ambac's ratings to "AA." This should kick off another drop in financial stocks and the rest of the market. If it doesn't, we'll know the recent rally in financial stocks has still got room to run. If it does, we'll make a bundle.
Disclosure: Author is short financial stocks.
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This article has 19 comments:
es
Great
Are there no conflicts of interest?
And yes, it's all BS.
Question for you, Mr. Summers: where did you get your figues of $17 Billion of debt? That's even higher than Ackman's estimated losses. Did you make that up too?
borenstein
Prevail by just printing money? May be the Fed will succeed by keeping big ibanks and commercial banks alive but for how long before even "government-cooke... inflation will exceed 10-20% and gas prices in the USA will go over $10-15/gallon?
Prevail by just printing money? May be the Fed will succeed by keeping big ibanks and commercial banks alive but for how long before even "government-cooke... inflation will exceed 10-20% and gas prices in the USA will go over $10-15/gallon?
Keep dreaming. There is no possibility to escape the reality and it is coming in a big way. It called a depression. Back then, from 1929 until 1931, the Fed too pushed interest rates low but commodity prices forced them to raise the rates in a big way...Then FDR started printing money but it did not help!
Great