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While stock investors are celebrating yesterday’s surprise rally in the Dow, most bond investors are bracing themselves for a new disaster of unquantifiable dimensions.
Ground zero of the new crisis: Precisely the companies that I said would be at ground zero — collapsing bond insurers like MBIA and Ambac, along with the hundreds of thousands of bonds they cover.
Indeed, it was in anticipation of this new looming disaster that we sent you “Next Phase of the Crisis: The Great Ratings Debacle” last November. And it was with the expectation that bond insurance could be the first big explosion of the new year that we made it our number #1 forecast in our last Safe Money Report. (See “Credit Crack-Up.”)
And Now, Just This Week …
It’s partly because of this disaster that the Fed has announced the largest one-day rate cut on record.
And it’s entirely because of this disaster that New York State officials are frantically trying to put together a rescue, pleading with big banks to infuse $15 billion of fresh capital into the distressed bond insurers.
Indeed, it was rumors of the rescue that caused a supposedly “huge” rally in MBIA and Ambac yesterday, which, in turn, sparked the surprise rally in the Dow.
But for anyone still able to break into a chuckle, the rally in the bond insurance stocks yesterday was a big joke:
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From its peak of $76.02 per share just twelve months ago, MBIA had collapsed to $6.75 last week, a decline of 91.1%; while Ambac had plunged from $96.10 to $4.50 in less than nine months — a 95.3% collapse.
In contrast to that massive loss of market value, you’d need a magnifying glass just to see yesterday’s tiny, picayune rally on the charts.
My recommendation: Sell the rallies.
Sell into any rally in mortgage company stocks, bank stocks, tech stocks and any others that are vulnerable to this credit crack-up. Take advantage of any higher prices to exit — to greatly reduce your exposure and get to safety.
Look. The collapse of bond insurers is not just a side show in a five-ring circus. It’s quickly becoming the main act. Just this morning, The Times finally explained what we exposed many months ago. Some excerpts:
“Next on The Worry List: Shaky Insurers of Bonds”
— New York Times, January 24, Front Page
“Even as stocks ended five days of losses with a surprising recovery on Wednesday, officials began moving to defuse another potential time bomb in the markets: the weakened condition of two large insurance companies that have guaranteed buyers against losses on more than $1 trillion of bonds.
“Regulators fear a possible chain of events in which the troubled bond insurers, MBIA and Ambac, might be unable to keep their promise to pay investors if borrowers default on their debt …
“To avoid a possible crisis, insurance regulators met with representatives of about a dozen banks on Wednesday to discuss ways to shore up the insurers by injecting fresh capital …
“The notion that the failure of even one big bond insurer might touch off a chain reaction of losses across the financial world has unnerved Wall Street and Washington. [And] it was a factor in the Federal Reserve’s decision on Tuesday to calm investors by reducing interest rates by three-quarters of a point, to 3.5 percent.”
The Big Problem: No One Wants to
Get Dragged Down into This Giant Morass
The New York regulators say they’re hoping big banks can pony up as much as $15 billion to rescue the bond insurers. But the facts say it’s a lost cause.
Fact #1. The bankers themselves are roaming the world, hat in hand, begging for capital infusions. They’re not exactly in a charitable mood.
Fact #2. No one has a clue as to how much it’s going to take to bail out these bond insurers. New York State is proposing $15 billion. Sean Egan, founder of Egan-Jones Ratings, says it’s more likely to take $30 billion. And the true potential liabilities are several times more.
Fact #3. Losses at companies like MBIA and Ambac will vary dramatically, depending on the future default rates of the securities they insure. And right now, those default rates are soaring, prompting regulators and rating agencies to scrap their earlier estimates, revise them, and then scrap the revised estimates — over and over again.
Fact #4. If the default rates surge as much as I think they could, the total bill for this disaster could be $50 billion, $100 billion, or even as much as the entire $145 billion economic rescue package Washington is rushing to enact.
Fact #5. When New York regulators asked Warren Buffett to help last year, he wouldn’t touch MBIA and Ambac with a ten-foot pole.
Fact #6. A smaller bond insurer, ACA Capital, has already been downgraded to triple-C, deep into junk territory. Not exactly a good sign for its larger brethren.
Fact #7. Until recently, everyone thought that subprime mortgages and collaterized debt obligations (CDOs) were the only problem bond insurers like Ambac and MBIA had to worry about. But now, even before the recession deepens, their traditional business of insuring municipal bonds is also in jeopardy.
Reason: State and local government finances are getting hit hard, opening up a whole new area of uncertainty for anyone who might infuse capital into these insurers.
Fact #8. Last year, the Feds tried to get the banks to join another rescue mission like this one — to bail-out Structured Investment Vehicles (SIVs). But the whole plan was dead on arrival.
So today, when distressed companies or government officials solicit bankers for bail-out capital, the bankers roll their eyes and say “Oh no. Here we go again!” They can’t afford it. And they’re not interested.
The Situation Is So Desperate
New York State Officials Say
This Deal Has to Close in 48 Hours!
Or it could be too late!
Maybe they’re overstating their case. Maybe not. No matter what, the telltale signs of urgency are obvious:
Bonds that are covered by default insurance are now actually cheaper than equivalent bonds without the insurance. The bond insurance business stinks so bad, investors are actually willing to pay extra just to avoid the stench.
The Fed has acted with its most dramatic single-day rate cut of all time, and it’s promising a lot more.
Gold investors, smelling a historic financial panic, have driven up the yellow metal by over $50 per ounce just in the last 48 hours.
Investors are so spooked — and so anxious for safety at any cost — they’ve driven the price of 30-year Treasury bonds to their highest level since they were first issued decades ago.
Financial markets all over the world are going haywire.
Consumers are snapping their wallets shut.
Governments are panicking.
What’s likely to happen next?
What should you sell that could get killed?
What should you buy that could turn this tragic drama into profit bonanza?
For the answers, don’t miss our urgent teleconference, “PREVIEW 2008: Major Dangers and Massive Opportunities.
It’s free. It’s a blockbuster. It’s perfectly timed for these events. And it’s online right now. To hear the 60-minute event immediately, here’s what to do:
Step 1. Turn your computer speakers up.
Step 2. Click on this secure link.
Good luck and God bless!
Martin
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