Dumbest Comment of the Year: Cramer Wants to Nationalize the Monolines
This is getting bizarre. I know shareholders like myself have been clobbered, not to mention those who have owned the companies for longer. But the dumbest thing to come out is Jim Cramer's recent suggestion that the government should nationalize the bond insurers. (here is an article on it and here is a video)
I don't know who has been feeding information to Cramer but most of his views on the bond insurers are completely misleading. First of all, monolines don't go "belly up". They go into a run-off process that can actually take decades. SCA has been in an almost "belly up" state for many months now and nothing happened. SCA was cut to CCC while Ambac (and others) will be at AA.
Futhermore, the stress tests that are used by the rating agencies use an extreme case to gauge the probability of paying claims. None of the monolines have paid out any big claims. They may but that can take years (since monolines typically pay principal and interest over time, as originally scheduled). Maybe Cramer is looking 3 years ahead--I doubt it--but the current situation is nothing like he is describing.
What I see happening is that people are looking for a scapegoat. The bond insurance industry is the ultimate scapegoat right now. They are too small (no strong lobby group; market cap small, even in the glory days; etc) and are in the middle of the alphabet soup from ABSes to CDOs.
If Cramer's plan goes through (very low probability but he does have political influence with high levels of government it seems), the shareholders of the 4 companies that he wants nationalized MBIA, Ambac, PMI Group, and MGIC, will probably lose everything. Although it would really be a bizarre situation where a company with a positive book value with no immediate cash crunch ends up being bought out by the government. I am also not sure what would happen to bondholders of these companies, not to mention the shorts or the CDS buyers who are betting on a default (since I doubt the government buyout would count as a default). I don't think Cramer knows what he is suggesting. The monolines play a complex intermediary role, with commplex relationships with market prices and market perception of risk, and you just can't save the situation by nationalizing them. I am sure Cramer and his friends at some of the banks are taking huge losses but the government can't solve this by throwing money at the problem.
I'm a free market guy (left-leaning liberal-libertarian) but this is nothing more than socialism for the rich. He wants the government to give $250 billion to the banks, instead of Bush's plan of giving them to middle and working class (Bush's plan is dumb too but it's better). Furthermore, this is gross manipulation of the markets and is bound to fail. Does he really think that $250 billion will avoid the market forces that are cleaning the system?
Word to Jim Cramer: stocks don't always go up. I may lose my investment in Ambac but it was a calculated risk and I'm willing to take the loss. Similarly, all the other equity investors in other companies know that they are taking a risk. Trying to bail out the financials is ludicrous. What happens when commodity stocks collapse next? Time to pump another $300 billion into them?
I don't know if Jim Cramer is ever going to realize that the economy is more important than the stock market. The Dow dropping 1000 points is not the end of the world. Similar drops have happened before and the world didn't end!
These companies, Cramer warned, could go "belly up" in weeks, if not days. If that happens, he predicts, the banks could quickly run out of capital, and the Dow could plunge as much as 2,000 points.
Cramer said the crisis could be avoided if the federal government steps in and purchases the four failing insurers and then pays out 50 cents on the dollar to the banks for the failed loans.
Under the current scenario, he points out, the banks get nothing and the whole economy suffers if the insurers fail.
With Cramer's plan, a single $250 billion injection could cure the entire problem and establish a bottom for the financial stocks. If this step is taken, he predicts, the Dow could rally as much as 2,000 points instead of losing 2,000 points.
I don't know who has been feeding information to Cramer but most of his views on the bond insurers are completely misleading. First of all, monolines don't go "belly up". They go into a run-off process that can actually take decades. SCA has been in an almost "belly up" state for many months now and nothing happened. SCA was cut to CCC while Ambac (and others) will be at AA.
Futhermore, the stress tests that are used by the rating agencies use an extreme case to gauge the probability of paying claims. None of the monolines have paid out any big claims. They may but that can take years (since monolines typically pay principal and interest over time, as originally scheduled). Maybe Cramer is looking 3 years ahead--I doubt it--but the current situation is nothing like he is describing.
What I see happening is that people are looking for a scapegoat. The bond insurance industry is the ultimate scapegoat right now. They are too small (no strong lobby group; market cap small, even in the glory days; etc) and are in the middle of the alphabet soup from ABSes to CDOs.
If Cramer's plan goes through (very low probability but he does have political influence with high levels of government it seems), the shareholders of the 4 companies that he wants nationalized MBIA, Ambac, PMI Group, and MGIC, will probably lose everything. Although it would really be a bizarre situation where a company with a positive book value with no immediate cash crunch ends up being bought out by the government. I am also not sure what would happen to bondholders of these companies, not to mention the shorts or the CDS buyers who are betting on a default (since I doubt the government buyout would count as a default). I don't think Cramer knows what he is suggesting. The monolines play a complex intermediary role, with commplex relationships with market prices and market perception of risk, and you just can't save the situation by nationalizing them. I am sure Cramer and his friends at some of the banks are taking huge losses but the government can't solve this by throwing money at the problem.
I'm a free market guy (left-leaning liberal-libertarian) but this is nothing more than socialism for the rich. He wants the government to give $250 billion to the banks, instead of Bush's plan of giving them to middle and working class (Bush's plan is dumb too but it's better). Furthermore, this is gross manipulation of the markets and is bound to fail. Does he really think that $250 billion will avoid the market forces that are cleaning the system?
Word to Jim Cramer: stocks don't always go up. I may lose my investment in Ambac but it was a calculated risk and I'm willing to take the loss. Similarly, all the other equity investors in other companies know that they are taking a risk. Trying to bail out the financials is ludicrous. What happens when commodity stocks collapse next? Time to pump another $300 billion into them?
I don't know if Jim Cramer is ever going to realize that the economy is more important than the stock market. The Dow dropping 1000 points is not the end of the world. Similar drops have happened before and the world didn't end!
Thanks for a great blog. Given the down-grade in Ambac, doesn't it mean that those whom they insure will have further write downs? Take a look at this list from their website: http://www.ambac.com/pdfs/Structured
ReplyDelete%20Finance%20Exposures.pdf
Wachovia seemes to have about 3.5 billion in credit enhanced securities. I looked on the Wachovia website, however, and could only find auto-loan securities. Have they already written these down?
In general, I have been trying to find out who will be hardest hit by the downgrade in Ambac rating. Won't it force some further write-downs and sales? Do you have any thoughts on this. Anything would be appreciated.
I empathize with your loss on Ambac. I made the same mistake.
-David
Thanks for the compliment.
ReplyDeleteOne thing that everyone keeps ignoring--Cramer especially--is that the downgrade is only from AAA to AA. This is not like SCA, which was cut from A to CCC. A rating of AA according to the rating agencies still means that there is a high likelihood of claims being paid.
The banks generally have NOT written down any losses from potential monoline downgrades (except for SCA--I believe Merril Lynch, CIBC, and others wrote that off completely). In conference calls given by the banks, when management refers to "hedges", some of that is the monoline insurance. Most banks still have not written it down.
I don't think they will write it off completely because an AA rating still implies a high probability of payment. I think the independent auditors (accounting firms) will probably be ok with leaving the hedges on the book as well. That's just a guess on my part and I don't work in the industry or anything. There may be some adjustments in cases where the banks think they won't be paid, but for the time being, they likely won't write things off to any sizeable degree.
The real big write-offs will come if Ambac (or others) are downgraded below, say, the A rating. If you go below A then the accounting firms, not to mention casual observers, will start to worry about payment. If it gets to that stage, that is when there will be mass write-offs.
Ambac got downgraded late in the afternoon yesterday and nothing really happened. Look at what the market did.
Ambac's stock price was actually positive most of the day (not sure why MBIA was clobbered at the same time) and finished slightly negative.
There wasn't any massive sell-off in bonds as far as I know. The investment banks and others with exposure also didn't fall off a cliff. Admittedly, Fitch downgraded the Ambac insured products after market close (if I'm not mistaken) but the market will have reacted when Ambac itself lost the rating earlier in the afternoon.
I think most of the downgrade from AAA to AA already priced in, and it won't have that much of an impact. Most of the insured bonds were trading down for several weeks (from what I understand). There may still be some negative impact when funds that can only hold AAA-rated paper sell stuff, but that remains to be seen.
The real test is if the ratings are cut further. Or if a smaller competitor was cut deeper. I'm not sure how much capital is needed by Ambac to maintain the AA rating but Fitch did say it is on ratings watch negative with possibility of further cuts.
I think all I have said sort of avoids your real concern. I suspect your concern is what happens if Ambac is insolvent and can't pay (i.e. its rating was cut to C or lower). If that happens, the banks will take losses equivalent to hedges. This is what worries people like Cramer but they are confused about the timing of it. Theoretically, the banks will have to write down the insured amount. In the absolute worst case where everything turns to zero, banks will have to write down around $400 billion from all the monolines (structured finance products by Ambac alone is worth $162.2 billion as of Dec 2006). But monolines will have enough money to make payments over time so this is a long drawn-out process. The banks with exposure also likely can take their time writing it down given the slow payments of most mortgage products.
It's sort of like if the bank had a 20 year mortgage with the insurer. As long as the insurer keeps making the monthly payments, the bank may not have to write down the mortgage. The problem is if the insurer can't make the monthly payment--we are nowhere near that IMO...
David,
ReplyDeleteI'm not sure if you are familiar but one of the best blogs on credit issues is AccruedInterest (accruedint.blogspot.com). He hasn't written about the current situation but I would hit that blog once in a while to gain his insights... one of the best bloggers on credit stuff...
Cramer has been hammering away at the monolines for months now. The story is pretty deep, and I believe is as much personal as it is professional. Generally, I'm not a conspiracy theorist but sometimes...well...
ReplyDeleteIn a simple 1,2,3..
Cramer operates the street.com financial website. The street.com was co-founded and financed by a man named Marty Peretz. Marty Peretz was the publisher of the New Republic magazine. He was also a business professor at Harvard. At Harvard he was teacher to and advisor of none other than Bill Ackman, the now famous short seller of MBI. Peretz not only was Ackman's mentor but helped finance the latter's hedge fund Pershing Capital. Cramer is also a friend of Ackman's and even admitted to such during a Mad Money show less than 2 weeks ago.
If we go back a few years, prior to Pershing, Ackman ran a hedge fund called Gotham partners. This is how it reads from an April '07 article -
" The failure of Gotham Partners, in late 2002 and early 2003 has faded as a hot public topic, but it isn't far from Ackman's mind, even today.
"We had some pretty difficult moments, but I don't regret any of the experiences," he said, seated near a shiny fighter jet's ejection seat displayed in the office as a signal to investors that they can always bail out.
At Gotham, Ackman and his partner tried to make up for poor performance elsewhere in the portfolio with aggressive bets, shorting Federal Agricultural Mortgage Corp. (AGM.N: Quote, Profile, Research), called Farmer Mac and bond insurer MBIA (MBI.N: Quote, Profile, Research).
They described their analysis on Gotham's Web site and sent regulators copies of the reports, hoping someone would begin probing problems they said they identified at the companies.
But much to Ackman's dismay, regulators zeroed in on the hedge fund, investigating whether Gotham had manipulated stock prices. While he was quickly cleared of any wrongdoing, investors fled and he had no choice but to shut down."
So now we have come full circle with Cramer calling in the regulators, proposing the government come in and take over the FG's. He could have easily asked the government to loan ABK and MBI 2 billion dollars each at 8% interest. That would be cheap.
Back in 1933, FDR started the Home Owners Loan Corp. HOLC floated bonds and used the proceeds to help distressed homeowners pay their mortgages. Over 1 million homes were saved and the HOLC, according to records, actually turned a profit. The problem now, within our government, is no creativity or imagination. Silly little tax cuts are just plain dumb. 800 dollars will not save 2 million homeowners facing foreclosure. It's a pipe dream. Bernanke is a student of the Great Depression but doesn't seem to have learned by his studies. He even publicly apololgized to Martin Feldsteins for the Fed's repressive policies of the 1930's! It's amazing. I like to believe we have smart people in this country but they seem to be in hiding. Might as well have chimpanzees running the show.
Ironically, it is probably Cramer who should be investigated.
I forgot to mention that the reason regulators began investigating Gotham and Ackman back in 1992 was due to MBI. They believed Ackman was spreading false imformation about MBI's finances and turned the table on him.
ReplyDeleteI have seen some stories on Bill Ackman before but it's hard to say if your theory is right with respect to Cramer. It does look quite fishy that Cramer started screaming at the monolines, just when they were about to raise capital. Nothing had changed in the last month (except Fitch's request for more capital) so why go off on the monolines this week? Cramer's comments probably led to the sell-off in the monoline stocks and made the situation worse (especially given that the rating agencies are supposedly using soft issues like market perceptions in their analysis).
ReplyDeleteAll I know is that Cramer doesn't know what he is talking about. He is a good trader and knows some stuff but what he was saying about the monolines is completely misleading. Ambac might go down and we might lose everything, but it won't be because of anything Cramer said.
Siv,
ReplyDeleteThank you for your lengthy and thoughtful response. It is much appreciated.
-David