Well folks, we thought we had seen it all. Turns out we haven't. All of which goes to show one thing: while things may indeed be getting curiouser and curiouser, there are apparently NO LIMITS TO HOW CURIOUS THINGS CAN ULTIMATELY GET. Another way of putting it might be this: our financial institutions make magicians, witchcraft, and voodoo look sane and rational by comparison with their antics.
We refer here to the truly astounding maneuvers surrounding the current intense efforts to bail out the muni bond insurers. The situation, as we have been able to unravel it, appears to be roughly the following:
1. Muni bond insurers, who had a great thing going insuring, and collecting premiums for insuring securities which would probably never require an insurance payout (i.e., municipal bonds) got greedy and gravitated toward insuring ultra-risky mortgage-backed bonds. Those whose bread and butter consists in properly evaluating risk bought rating agency gilt-edged ratings of iron pyrite mortage-backeds hook, line, and sinker;
2. When the inevitable blow-up occurred, and those financially incapable of making usurious interest rate payments on their mortgages stopped paying, the mortgage-backeds went into their inevitable tailspin;
3. This severe decline increased the size of probable calls upon bond insurers to make good on the many hundreds of billions in insurance they had written on mortgage-backeds. Each downward ratchet in the market value of the insured mortgage backeds -- which in many cases failed to reflect even remotely the true extent of the decline of bonds which often had become unsalable at ANY PRICE -- increased the probable, impending liability of the bond insurers to degrees which, if realized, would erode the remnant of bond insurer capital, placing said bond insurers irrevocably into Chapter 7 territory. As far as those banks and other financial firms who hold huge quantities of "insured" mortgage-backeds is concerned, the daily growing impossibility of the insurers' making good on their obligations placed more and more of the banks' remaining capital in the red zone. Indeed, even with the substantial foreign capital infusions into the banking system, it is difficult to believe that any number of major banks is really solvent today. (This reminds us of the Japanese situation, where the Bank of Japan (BoJ) years ago placed the entire banking system on life support in order to preclude an accurate marking to market of bank balance sheets, since this would have caused the bankruptcy of the entire banking system).
4. This situation has generated a panicky rush to AVOID the necessity of writing down any additional losses the banks have been legally constrained to write down to date. Such further writedowns, after all, would not only place the banking system much closer to the undeniability of de facto insolvency, but would also likely DETER any further substantial recapitalization inflows from "sovereign wealth" funds or any other source. These funds may not be that smart, but they are not totally stupid, we would presuppose.
5. The current "bailout" effort re. the bond insurance firms will, if published reports are to be believed, be financed by the banks. The banks, in other words, will be bailing themselves out -- at a much lower current capital outlay than would be the case should the bond insurers go under or lose their highly prized, and totally undeserved, AAA ratings. Unfortunately for the banks, this effort constitutes an effort in black magic. If the "bailout" succeeds, it will be a temporary success -- very temporary.
6. What the bailers-out really hope to achieve here -- and indeed, what they have sought to achieve all along -- is a restoration of "confidence." The restoration of confidence would, in theory at least, halt the downward spiral in muni-backed bond prices. The refusal to buy would be replaced by a willingness to buy discounted bonds for their fine, so-called yield. The value of the banks' capital base, and their lendable capital, would cease shrinking. The crisis would have been, at least partially, negotiated.
7. The problem with attaining this objective is the same one we have cited in earlier posts. The issue is not lack of confidence as such, but a SOUNDLY-BASED REFUSAL TO RISK FINANCIAL HARA-KIRI on the part of investors who, in their prior greed and failure to do proper due diligence on their investments, have already LOST HUNDREDS OF BILLIONS OF DOLLARS/EUROS. As we have noted in an earlier post, while P.T. Barnum's formulation may be correct: "There is one born every minute" (read: suckers), THERE IS NOT ONE BORN EVERY SECOND. Ergo, the banks' strategy will NOT cut it. Even the most obtuse recognize that the MUSIC HAS STOPPED, AND WILL NOT RE-START. Those who have managed to grab a chair, or a portion of a chair, are not likely to succumb again to the banks' whispered sweet nothings.
IT IS ANALYTICALLY CRUCIAL to bear in mind that if writedowns can be averted via a "successful" recapitalization and bailout of the bond insurers, that does not REDUCE THE TRUE IMPAIRMENT of the banking system's capital base and lendable assets, nor does it DISTANCE by even one millimeter the true distance of the major banks from DE FACTO INSOLVENCY. After all, the source of this impairment/proximity to insolvency has nothing to do with the ability to SEEM TO BE ABLE TO PASS THE RISK on to the bond insurers: it is only if the bond insurers can actually make good on their hundreds of billions in obligations, if necessary, that the banks do maintain their current capital position and freeze their movement toward insolvency. Since the "bailout" is a matter of a few tens of billions, while the sum required if worst case (and, let us be frank, increasingly probable) scenarios materialize would be in the HUNDREDS OF BILLIONS, the discussed bailout is not a real bailout in any sense, but only a time-gaining device. During the "gained time," if the downward spiral in real estate prices is NOT halted and reversed, and if mortgagess are NOT bailed out by Uncle Sam, a new bailout will be required in several months. And then another, and another, etc. etc.
What we are witnessing in the case of the current bond insurer "bailout" effort is simply one more uncoordinated element in what we have termed "Bailout by Bits and Pieces." Unfortunately, the downward spiral in real estate prices is in full swing, and nothing short of a full-fledged bailout by UNCLE SAM can secure the banking system. We are talking here of many hundreds of billions, perhaps even a trillion or two.
Of course, as those readers who have been reading this blog since its inception last August know, this is precisely what we have been saying ALL ALONG.
And IT WILL COME TO PASS. The longer Uncle delays a full-bore RESCUE, the more expensive it will get, and the longer it will take for recovery.
