'Cascading' Losses Coming for Bond Insurers

Friday, Feb. 1, 2008 1:49 p.m. EST

Expect lowered corporate credit ratings and then a "cascading series" of losses from leading bond insurers, including MBIA and Ambac Financial Group, analysts tell MoneyNews. David Dreman, founder of Dreman Value Management LLC, considered a bond market guru, told the business press this week that he expects "major losses" for bond insurers.
Dreman spoke after Fitch Ratings lowered its rankings on Financial Guarantee Insurance this week. That has lead other leading market watchers to speculate that other top bond insurers will suffer a similar destiny. "If bond insurers, like MBIA and Ambac have their credit ratings lowered from AAA to AA, or lower, which seems inevitable, it will cause a cascading series of losses on Wall Street and problems on Main Street," says Jordan Goodman, an investment analyst and radio commentator.

"MBIA and Ambac have guaranteed mortgage-backed securities which have plunged in value because of delinquencies and foreclosures, which is causing huge losses," says Goodman, author of "Fast Profits in Hard Times." Other investors, noting that those companies collectively guarantee $2.4 trillion in securities, have been selling off the stocks of the bond insurance firms. The price of shares for Citigroup, the largest American bank, by assets, JPMorgan Chase, Merrill Lynch and Morgan Stanley, as well as Ambac and MBIA, have been negatively affected this week, as investors fear continued fallout. "If their credit ratings fall, these mortgage-backed securities firms will fall in value even more, causing many more billions in writedowns from Citibank, Merrill Lynch, UBS, Lehman, etc.," says Goodman. A reduction in the investment grade of a corporate bond from to AA from AAA potentially jeopardizes ratings on all of the securities the insurer guarantees and also limits the company's ability to generate new business. That also may raise borrowing costs for others, says Goodman. Eight large banks have teamed up to seek a rescue plan for MBIA , Ambac Financial Group and other troubled bond insurers battered by the global credit crunch. Media reports indicate the eight banks include: Barclays, BNP Paribas, Citigroup, Allianz's Dresdner Bank, Royal Bank of Scotland Group, Societe Generale, UBS and Wachovia. Insurer credit ratings are set not only by Fitch, but also by Moody's Investors Service and S&P, and these firms are reviewing earlier assessments.

They are concerned that MBIA and Ambac won't be able to cover losses on securities they guarantee. Thus the speculative move by the eight banks. One analyst, Meredith Whitney of Oppenheimer, said banks could write down an additional $70 billion if bond insurers have their credit ratings revoked.

She has downgraded Merrill and speculates that it alone may face writedowns of as much as $10 billion, but Merrill's CEO John Thain claims that company faces maximum losses of just $3.5 billion. The Federal Reserve Bank's reduction of interest rates -- twice in the last two weeks -- is expected to have an impact on the economy, but that may not be felt for up to 12 months.

Profits, for the latest reporting period, have declined 33% on average, dragged down by losses at Citigroup and Merrill.
What's more, overall economic growth slowed to an annual rate of 0.6 percent from October to December, according to the Department of Commerce. Many firms are changing strategies, at least for the short-term, based on the economic signals. But that's no guarantee of investing success. "Be aware that many good plans -- financial -- fail because they are not fully implemented," says Jim Trypak, president of the Society of Financial Service Professionals. What's an investor to do with the conflicting signals? Now may be a time to buy certain stocks. Dreman disclosed that he has purchased shares of Bank of America and Wachovia. Why? He sees a lot of panic in the market right now.

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