My neighbour and I were again at our favourite meeting place across the fence.
The neighbour opened by expressing deep concern about the way the share markets around the world were falling.
‘As you know, I have a large share portfolio, and the way the markets are going, I also have large paper losses. When will it all end.?
‘Well you know neighbour, the world share markets are reacting both to the early stages of the American recession, and the large losses at the banks, which can only gets worse. There has been some recovery in world share markets from the way they panicked the other day, but there are difficulties still to be resolved.
‘So far, the international banks have owned up to revaluations downward in asset values of US$107.8 billion, and now Societe Generale of Paris adds another 2.45 billion Euros made worse by a rogue trader. But for the banks as a whole, there is still a likely further $300 billion write downs to come.
‘This will have to include falls in commercial property values, which the banks have lent against and the securitisation and funny money collaterised debt obligations (CDOs) tied to them, which are falling in value. There are also private equity buy-outs, which look like the’re headed for the rocks, and the banks have participated in their purchase.’
‘And what happens to the share markets while all this is going on?’ asked the neighbour.
‘The world stock markets are in bearish territory and can be expected to fall further. I can only repeat that it will take time. In the meantime, contemplate the shares and other securities you would like to buy when the panic is finally over.’
‘It’s hard to sit idly by and watch your assets go down the slippery slope.’
‘Neighbour, go back and worry about your business. It’ll take your mind off the markets at least for a while.’
‘I’ll try and follow your advice, but it is difficult for me to do so. I’m a born worrier.’
‘Neighbour, there is still a possibility of a global credit pandemic as Merrill Lynch’s chief investment strategist, Richard Bernstein reported on January 22 2008. This is a far more concerning issue than the gyrations of the share market.
‘Bernstein’s point is that the action of central banks in controlling short term interest rates doesn’t have any bearing on the availability of credit. The central banks only control the price of credit. So, the Federal Reserve’s sudden drop in the federal funds rate by 0.75 per cent won’t help much in freeing up the availability of credit, without which no economy can grow far.
‘This is why the most recent actions by regulators to strengthen the monoline insurers is so important. The monolines stand behind US$2.4 billion of municipal and structured debt, which if they fail would severely damage the world financial markets at such a critical time. MBIA and Ambac, which are in difficulties holding on to their precious triple-A ratings due to insuring a large number of very toxic securities are struggling.
‘Getting insurance from the monolines has been up to now a passport for lesser ranked corporates and infrastructure assets to borrow in the capital markets, and for the monolines to act as counterparties behind municipal and structured debt. MBIA as the largest monoline insurers stands behind about US$652 billion of corporate debt, and Ambac, the second largest monoline stands behind about $546 billion, which would be severely dented if these two monolines lost their three star ratings.
‘Enter Eric Dinallo, the top insurance regulator in the State of New York. He was appointed Superintendent by Governor Eliot Spitzer in April 2007. Dinallo is widely experienced in securities and insurance regulation at the state government level, and as global head of regulatory affairs for Morgan Stanley, and most recently as general counsel for Willis, the world’s third largest insurance broker.
‘Just as Eliot Spitzer made his reputation as enforcer of the corporate rules against both leading corporates and Wall Street firms, when he was Attorney General of New York State in the early 1990s, so too does Eric Dinallo want to do the same as the most important and powerful man in insurance. His first job is to protect the policy holders, with immediate concern about the solvency of the monolines.
‘Dinallo has been trying to convince the big banks and investment banks to rescue MBIA and Ambac by way of injecting capital, and the figure of US$15 billion has been suggested. Given the can of worms in the two monolines, there is obviously great reluctance by the likes of JP Morgan Chase, as one of the three top American banks and by Goldman Sachs, the largest of the investment banks, both of which have been lightly touched by the subprime/CDO disaster.
‘Citigroup and Merrill Lynch, the two most heavily affected by the disaster have little spare capital to throw in the ring. At time of writing, the fate of the two big monolines hangs in the balance.
‘Eric Dinallo has also spoken to Warren Buffett, the second richest man in America, whose firm Berkshire Hathaway is opening its own monoline insurer, but little is expected from that quarter.
‘A billionaire corporate investor in distressed assets, Wilbur Ross is said to be looking at the likelihood of making a bid for Ambac, while Marty Whitman, another super rich distressed asset investor, who owns 10 per cent of Ambac’s equity and a large parcel of its 14 per cent notes, which are underwater wants to see a restructuring of the company.’
My neighbour said: ‘I see my problems pale into insignificance compared to the distress in some of the big banks, but even so worry becomes me, I can’t help it.’
I said: ‘Let’s stop now, and we’ll meet again in a few days.’
