And NOW Young Monoline… You Will Die

Moody’s has downgraded FSA and Assured Guaranty on Friday, claiming that with the future of municipal monoline insurance uncertain, it is unlikely that any stand-alone insurer could ever get a Aaa rating. I predicted the death of these insurers back in July when Moody’s first put both on negative watch. For several months it appeared I was wrong, as either FSA or Assured wrapped approximately 22% of all new municipal issuance from August 1 to today. Assured’s stock price rose from $11 to $17. They worked out a deal to re-insure CIFG’s muni book. They agreed to purchase FSA. All in all it seemed like there were plenty of believers in municipal insurance.

But Moody’s was the only doubter that mattered. Now municipal bond insurance is all but extinct.

Now I’ve outlined a good case for why municipal insurance should continue to live on. But forget about that. One can also make a case that FSA and/or Assured Guaranty shouldn’t get a Aaa rating because of issues related to those companies specifically. But that’s not what I want to talk about either.

What bothers me is Moody’s assertion that demand for municipal bond insurance might decline and therefore no firm can get a Aaa rating.

Here is the problem with Moody’s stance. It has nothing to do with their actual view of municipal insurance. Its painfully obvious that this is nothing more than CYA. Its like a referee doing a make-up call. They completely screwed up structured finance ratings from 2002-2007 or there abouts. And thus they have a lot of egg on their face in regards to FGIC, Ambac, MBI, etc.

So now they want to act all tough and refuse to give Aaa ratings to monolines under any circumstances. Does this make any more sense than when they were giving out Aaa like business cards? Aren’t they essentially making Assured Guaranty pay for the sins of FGIC?

Consider this. Let’s say that a new municipal insurer is created and that insurer acquires all the municipal policies from Ambac. Now let’s say that the new insurer has enough capital such that if it immediately went into run off, it could pay all realistic potential premiums with a significant cushion. What is “realistic” and “significant” in the previous sentence would need to be defined, but there is no reason why Moody’s can’t come up with those numbers.

Why can’t such a firm be rated Aaa?

Notice how in the above scenario, the firm’s ability to generate new revenue isn’t relevant. The firm’s ability to raise new capital isn’t relevant. Its simply does the firm right now have adequate capital to pay its liabilities. Why is that concept so unreasonable?

For Moody’s to claim they cannot rate on this basis is a total cop out, because this is exactly how all securitized deals are rated. A securitization is always a closed loop. The ratings have to be based available capital versus expected losses. Obviously mistakes were made in rating securitized deals in recent years. But for Moody’s to claim they cannot rate on such a basis is complete bullshit. Do we need to alter our models? Absolutely. But Moody’s cannot on one hand claim to be a competent ratings agency and on the other hand claim they can’t estimate muni losses versus available capital.

Municipal insurance benefited both investors and municipalities. Now it will die, all because Moody’s doesn’t have the courage to rate insurers based on dollars and cents. Instead they are rating based on public relations.

And by the way, why the hell has AGO’s stock price risen since this news? They are toast, and I’m short.

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Accrued Interest provides unique, expert insight to developments in the U.S. bond market. It is written by an anonymous professional working in the field.

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