Confidence Game - Christine Richard [108]
Then on November 5, Fitch Ratings, the smallest of the three rating companies, said it planned to spend the next six weeks reviewing the capital of all the bond insurers. Fitch stopped short of putting the companies under formal review for downgrade. The credit-rating company warned, however, that recent downgrades of mortgage securities had been “broader and deeper” than Fitch had anticipated. Any bond insurer that failed the test would have a month to raise capital or have its rating cut. The companies were being given a running start.
On November 8, 2007, Moody’s Investors Service followed up with a similar warning. By the end of the month, Standard & Poor’s (S&P) began its unofficial review.
What would it mean if the bond insurers lost their triple-A ratings? Bloomberg News collected some data and came up with an estimate that it would cost investors roughly $200 billion. It was almost certainly a conservative guess. Greg Peters, head of credit strategy at Morgan Stanley, summed it up. “We shudder to think of the ramifications,” he told me. It would be “a huge destabilizing force.”
For several weeks, the financial world waited for the credit-rating companies to rule. “We’re all rooting for the bond insurers,” a banker on the asset-backed securities desk of a bank in London told me. Without bond insurance, underwriters were going to find it next to impossible to sell asset-backed securities. Everyone’s job depended on the market picking up again. “Believe me,” he added, before leaving me with an indelible image of Wall Street’s support for MBIA and its competitors, “we come into work every morning with our pom-poms.”
ON NOVEMBER 8, the day ACA Capital, the smallest bond insurer, announced results, it became clear just how devastating a credit-rating downgrade could be. ACA Capital was the only A-rated bond insurer among a field of companies with triple-A ratings. The New York-based company was founded by Russ Fraser, a longtime ratings-company executive, who had been forced out by the board of directors in 2001 over his refusal to insure CDOs.
Fraser didn’t understand or trust CDOs that required analysts to abandon traditional credit analysis and rely instead on complex financial models. “Every PhD in the world is saying this is noncorrelated risk,” Fraser recalled of the CDOs brought before ACA’s credit committee. “But every CDO we looked at had the same 60 to 100 names. And they were never Exxon, Mobil, and Shell. The names were WorldCom and Enron and Tyco.”
By the fall of 2007, ACA Capital backed $65 billion of CDOs. Now, instead of exposure to Enron, the insurer had exposure to subprime. As a result, it announced a $1.7 billion writedown on its portfolio. Alan Roseman, ACA’s CEO, came out swinging on the conference call to discuss the quarter’s results. “We do not have a capital-adequacy issue according to S&P’s commentary and analysis,” he said. “Any public speculation or rumor to the contrary is at best misguided or at worst an intentional effort to negatively influence our stock price.”
The bond insurer’s clients were being “fed fiction” about the company, Roseman told listeners. The company faced no liquidity issues, at least not at its current rating level. And there was no reason to believe its rating would be cut.
“ACA is principally paid to absorb market price volatility,” he explained. “We assume the positive and the negative over the life of the transaction, thereby providing a market hedge for our counterparties.” The company was “absorbing” losses of $1.7 billion for