There have been two events over the last 5 days that signal the financial markets are nowhere near and end to their problems. These events indicate the depth and breadth of the problems we currently face.
Bond Insurers Splitting Themselves Up
Bond insurers are sometimes called "monoline" insurers because they only have one line of business. Some bond insurers use to only provide insurance for municipal bonds. However, some of those insurers branched out into subprime insurance over the last 7 years. The problem is these insurers aren't financially ready for a collapse of the subprime market. As a result, their respective stock prices have tanked and they have come under increasing financial pressure.
Now two companies have broached the idea of splitting themselves into two companies -- one company that insures municipal debt and one that insures subprime debt.
FGIC seeks to split itself up:
The beginning of a messy endgame to the bond-insurance crisis may be underway, and the industry that emerges could look very different from the one that bet big on subprime mortgages.
On Friday, FGIC Corp., holding company for the nation's third-largest bond insurer, told the New York State Insurance Department that in effect it wants to split up the business. The idea would be to create a new company to insure safe municipal bonds and for the existing one to keep responsibility for riskier debt securities already insured, such as those tied to the housing market.
The move may help regulators protect investors who have municipal bonds insured by the firm. But it could also force banks who are large holders of the other securities to take significant losses. Some banks that have been talking with FGIC in recent weeks to bolster the firm were taken aback by the announcement and could yet try to block it, say Wall Street executives.
Ambak seeks to split itself up
Ambac Financial Group Inc. is in discussions to effectively split itself up in a move aimed at ensuring that municipal bonds backed by Ambac retain high credit ratings, according to a person familiar with the situation.
A deal could fall apart because of the complexities in such a move, this person said. Bond insurers in recent weeks have become ground zero in the global credit crisis because the companies contractually have agreed to stand behind billions of dollars in securities underpinned by U.S. subprime mortgage loans.
A halving of Ambac would create one unit that insures municipal debt and one that would cover rapidly diminishing securities tied to the mortgages in a structure that effectively creates a so-called "good bank" and "bad bank." Bond insurers generate revenue by promising to cover bond payments on debt issued by a range of entities, including local governments. Bond insurers now are under pressure, though, because they also agreed to guarantee payments on mortgage debt or securities to banks, brokers and investors.
These companies are trying to save the good business and dump the bad business. At this point there is little else they can do.
But notice this statement from above:
But it could also force banks who are large holders of the other securities to take significant losses.
Banks that hold subprime paper backed by one of these organizations would face another round of writedowns. The value of the debt currently on their books assumes the bonds have insurance. Splitting the companies more or less forces the bad banks into a terrible financial position at best. So, these banks would face more writedwowns, which is the last thing the financial system needs right now.
UK Nationalizes Mortgage Lender
The U.K. government has decided to take full control of troubled mortgage lender Northern Rock PLC, in a surprise move that reflects the depth of the global credit crisis and represents an embarrassment for Prime Minister Gordon Brown.
After a tense weekend of last-minute negotiations with two bidders -- a consortium led by entrepreneur Richard Branson's Virgin Group Ltd. and Northern Rock's own board -- the government decided that it could best serve the interests of taxpayers and consumers by "temporarily" nationalizing the bank, Chancellor of the Exchequer Alistair Darling told a hastily called news conference yesterday. He said the government would introduce the necessary legislation this morning, and that a new management team led by former Lloyd's insurance market Chief Executive Ron Sandler would assume operational control of the bank immediately.
"I wanted to see a private-sector solution, but it had to be on the right terms," said Mr. Darling. "Governments have to see these things through." He said the bank would continue to operate as usual, making loans and taking deposits, but that its shares would be delisted before trading opened today on the London Stock Exchange.
Taking full responsibility for one of the country's largest mortgage lenders is a politically treacherous move for the government, which has faced strident criticism for its role in the affair since September, when its announcement of an emergency bailout package triggered the U.K.'s first bank run in more than a century. The decision amounts to a bet that it can manage the lender -- which owes the government some £25 billion ($49 billion) -- and then sell it at a better price sometime later, when financial markets improve. Mr. Darling said he still hopes to find a private owner for Northern Rock as soon as possible, though he declined to set any target dates.
First, this is a bail-out plain and simple. A company that engaged in reckless financial behavior is being rewarded under the "we're too big to fail" doctrine.
However, it also indicates just how bad things are. First, notice there were only two bidders for this company at the end. That fact tells us something very important -- there aren't any bidders out there for companies. If Northern Rock put itself up for sale during a healthy market it would attract a ton of bidders because it's a big business in a large economy.
But no one is bidding. That tells us that either
-- No one wants the business, and/or
-- No one can afford the business.
Most likely, the answer is a combination of the two.