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MBIA Sues To Get Out Of CDS Exposure

When in doubt kick 'em when they're down. That might as much as anything might be the rationale behind MBIA's suit to void credit default swaps it sold to Merrill Lynch.

MBIA is seeking to void half of its $5.7 billion of CDS that it sold to Merrill and recover payments made to counterparties. From the WSJ:

"The credit default swaps guarantee losses on tranches of collateralized debt obligations, and MBIA said Merrill Lynch had a "deliberate strategy" to offload billions of dollars in deteriorating U.S. subprime residential mortgages by packaging them into collateralized debt obligations or hedging their exposure through swaps guaranteed by insurers like MBIA.

Based upon Merrill Lynch's alleged misrepresentation, two MBIA units insured billions of dollars for the credit default swaps on the super-senior and senior tranches of four CDOs.

As a result, MBIA said it faces losses from the four CDOs in excess of several hundred million dollars."

This complicates things. Now how do you go about analyzing the balance sheet of BofA or for that matter any other financial institution that relied on CDS to offload credit risk. If MBIA were to prevail wouldn't that call into question the actual value and therefore protection afforded to others via these contracts? Even if they don't it's going to inject a lot of uncertainty.

If you think about it, this is probably a pretty predictable outcome. There's not that much case law surrounding these things so why not try and wriggle out through the courts. Merrill doesn't exactly have clean hands so they might well be willing to negotiate. If it works, look for more.