Underwrite This, Buddy

Man, talk about a house of cards. AP (12.19.07), via Eschaton:

"Treasury prices rallied on renewed demand for safe assets Wednesday after a Standard & Poor's Ratings Services downgrade of a bond insurer seemed to foreshadow more troubles for fragile credit markets.

The agency sharply reduced its rating for ACA Financial Guaranty Corp., which provides insurance to a wide variety of borrowers in the corporate, municipal and mortgage-backed markets, to 'CCC,' which is below investment grade. Previously ACA carried an investment grade 'A' rating.

Treasurys Rise, S&P Slashes ACA Rating

"The downgrade was viewed as meaning that banks could be forced to take heavy losses on debt they insured with ACA."

What's even worse is that "S&P cut outlooks for MBIA Inc. and Ambac Financial Group Inc., which are larger players in the bond insurance sector than ACA, to negative from stable. S&P also issued negative outlooks for two more bond insurers, Financial Guaranty Insurance Co. and XL Capital Assurance Inc."

In fact, MBIA and Ambac are the "the world's largest bond insurers".

Why is this a big deal? Financial Times (11.09.07):

"Because ACA Financial is rated A – well below the industry norm of AAA – its CDO CDS [CDS - as in credit default swap] contracts contain a provision requiring it to post collateral in the event of a downgrade, said the market participant.

Such provisions require ACA to post cash equivalent to the mark-to-market loss of the CDS contract pursuant to a ratings cut.

ACA’s downgrade threat could leave CDS counterparties without recourse

"In the event of a downgrade by S&P, ACA Financial would become insolvent, confirmed company Treasurer Alex Willkomm."

Which means its insurance becomes (as if it isn't already) worthless. Which means our Jolly Bankers would have to take all of this shitty debt back onto their books (all $69 billion of it), and come up with reserves to cover it. Ouch.

And there are bigger insurers out there who are in trouble too.

UPDATE: Some context. Bloomberg (12.15.07):

"Without guarantees, $2.4 trillion of bonds may fall in value and some issuers would get shut out of the capital markets."

MBIA, Ambac Downgrades May Cost Market $200 Billion