So Far, Hype Exceeds Progress on Bond Insurer Rescue Front

Despite New York insurance superintendent Eric Dinallo’s desire to move a rescue of bond insurers along with all possible speed, and the very real pressure of an imminent downgrade (note that Security Capital Insurance was downgraded five levels by Fitch yesterday from AAA to A), there was perilous little in the way of progress. Indeed, the very limited reports from the sessions themselves were not encouraging.

The view from afar, as from Davos, about the prospect of a rescue is positive, perhaps desperately so. As the Financial Times’ Gillian Tett tells us:

As news of a possible bail-out of the monoline industry trickled out on Wednesday night, one senior investment banker in Davos sent an urgent message to his junior staff: crunch the numbers to work out whether this makes financial sense for the banks – or not.

The answer? “We are still running the metrics,” he told me yesterday. “But we think that injecting capital would be cheaper for the banks than making write-offs [against a monoline downgrade]. We would seriously consider taking part.”

Similar debates are now undoubtedly occurring all over the financial world. For though the workings of the monoline industry used to be a topic which only excited geeks – or FT market reporters – almost all the financiers I have met so far in Davos believe it will be difficult (nay, impossible) to restore confidence in the financial world without a “solution” for the monoline problem.

When I read “solution,” I think, “Final Solution.”

I don’t buy one bit of Tett’s reasoning:

However, the proposed monoline bail-out idea does seem to have more merit. After all, the monoline initiative is not necessarily about propping up market prices per se – but more about dealing with counterparty risk. Moreover, there is a case to be made that the investor reaction to the troubles at the monolines has recently become a trifle extreme – partly, as I noted above, due to widespread ignorance about how the monolines actually work.

Those who have read the Pershing Square analyses, or summaries thereof, don’t find the reactions extreme. But to the premise: pray tell how is a rescue not a propping up of prices? No one would care about the monolines’ fate if the value of most of instruments they insured did not depend on the ratings. And the credit default swaps market and the secondary market price of MBIA’s bond issue say that the debts are at high risk of bankruptcy, therefore the guarantees are also at high risk of being worthless. So this most assuredly is about propping up the underlying value of these securities in order to keep prices from collapsing. To pretend otherwise is wrongheaded.

Back to the events du jour. Closer to home, things do not look so pretty on the rescue beat. The Journal gives a surprisingly blunt take, “Bond-Insurer Rescue Effort Faces Wall Street Skepticism“:

Mr. Dinallo said he wants to solve the problems “as soon as possible.” However, he said, “these are complicated issues involving a number of parties, and any effective plan will take some time to finalize.”

The shares of MBIA and Ambac, which had risen sharply on news of the plan, gave up much of their earlier gains. However, the story that Wilbur Ross was looking at investing in Ambac pushed the shares up in after-hours trading.

The Journal discussed exposures of key players, Merrill with $3.45 billion of “super senior” CDOs, Citi with $3.8 billion:

But it isn’t clear whether those firms would have the money, or the inclination, to use it to aid bond insurers. One consideration might be whether they think the cost of participating in a bailout might be greater than any loss of value in their holdings.

Note also they will get tax deductions on losses, which they can carry forward, while an equity investment offers no tax bennies.

And we get to the real fly in the ointment: even if Dinallo can reach a deal with a funding group, will the bond insurers accept it? I am not an expert on insurance regulations, but it seems to me there is a case to be made that the financial statements the insurers have been filings are misleading. Dinallo needs to be willing to use whatever tools he has to threaten a regulatory takeover (in effect, putting the insurance subs in runoff mode) to cudgel the board at the parent company level into submission.

The coverage from CNBC was even more downbeat. From “Bankers Downplay Reports of Bond Insurer Rescue“:

Bankers who met with New York insurance regulators to discuss a reported bailout of troubled bond insurers downplayed the meeting’s significance Thursday, with one calling it a “non-event.”

Bankers told CNBC that there was no consensus formed at the meeting and no movement on creating substantial plans for a rescue. Moreover, reports of the meeting may have made a bad situation for the industry worse, bankers said, as a subsequent jump in bond insurer stock prices scared off private equity firms that may otherwise have injected capital into the companies.

And the last complicating factor: the Street neither likes nor trusts Dinallo. From the Journal:

By exploring a bailout of the nation’s bond insurers, New York State Insurance Superintendent Eric Dinallo is tackling a problem that threatens Wall Street and ordinary investors alike….. At the same time, he has another potential obstacle. In a previous job, he rubbed many influential Wall Street figures the wrong way — including some he is now turning to for help…..

Mr. Dinallo has a colorful history with some of the firms and executives he is now leaning on to come up with a rescue plan. The 44-year-old lawyer made his name on Wall Street while working as the top investigator from 1999 to 2003 for Eliot Spitzer, who was then New York’s state attorney general….

Messrs. Spitzer and Dinallo led a very public campaign against Wall Street that in 2003 resulted in 10 big Wall Street firms paying $1.4 billion to settle allegations they issued tainted stock research in a bid to win more lucrative investment-banking business. Some executives on Wall Street felt that Mr. Dinallo was part of a team that was prone to making sometimes inflammatory public statements….

Today, some executives currently dealing with Mr. Dinallo on this latest issue said they now proceed with caution on dealing with him because of their previous dealings.

And it also appears the regulator has not been taking sufficient care to improve his image. From the Financial Times:

Meanwhile, there is justifiable unease among some bankers about how this bail-out has been organised. “The state regulators have put a gun to our heads and we just don’t like that,” complained senior one banker to me. “This smacks of something cobbled together by people without the experience. This is not how it should be done.”

While it may seem silly to let egos get in the way when there is so much to be gained or lost, the fact is that dealmaking requires highly developed interpersonal skills, particularly negotiating skills. And in a deal with multiple parties with differing economic interests (no one wants to tip their hand, no one wants to be taken), the dynamics are particularly fraught. It requires time and attention to the dynamics of the room as well as the issues on the table. Too many people focus on content and unwittingly let tensions build that lead to ruptures later.

Unfortunately, experience as a litigator is likely to have given Dinallo the wrong reflexes. And he may lack the sense to delegate the vital negotiation/facilitation role to someone who can pull it off.