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March 19, 2008 – Comments (12)

Merrill Sues XL Capital to Maintain CDO Insurance (Update2)

By Jody Shenn

March 19 (Bloomberg) -- Merrill Lynch & Co. sued XL Capital Assurance Inc. to force the bond insurer to honor $3.1 billion of guarantees on collateralized debt obligations as the securities firm attempts to avoid more writedowns of mortgage-backed debt.

``We filed suit to make clear that XL Capital Assurance Inc. is required to meet its contractual obligations,'' Mark Herr, a spokesman for New York-based Merrill, said in an e-mailed statement today.

CDOs, which repackage mortgage bonds and other debt into new securities, were the biggest source of the more than $195 billion of mortgage-related writedowns and losses at the world's largest banks and securities firm since the beginning of last year. Merrill's $24.5 billion in writedowns top the list. Banks had tried to limit such losses by taking out insurance from companies such as XL, a unit of Security Capital Assurance Ltd.

Other bond insurers including MBIA Inc. and Ambac Financial Group Inc. may also seek to cancel $100 billion of contracts on CDOs tied to subprime mortgages that they wrote if they're unable to shore up capital through other means, according to Janet Tavakoli, president of Chicago-based Tavakoli Structured Finance.

``Apparently in light of the current dramatic downturn and deterioration in the credit markets, defendants are having `sellers' remorse,''' Merrill said in the complaint filed today in Manhattan federal court.

The above is from Bloomberg.

It appears that the above references a Swap agreement that the counterparty can't pay off.  Buffet calls swaps the WMD of the financial world.  Considering there are over $45 Trillion dollars of such relationships, one can see why.

Many bond and equity investments are preceived to be insured by swaps.  What if the insurance is not good?

Mommy, why are all those men sweating?

12 Comments – Post Your Own

#1) On March 19, 2008 at 5:27 PM, alstry (36.13) wrote:

In case anyone is questioning the concern this blog overtly puts forth:

A quote from the esteemed Howard Shultz today:

"We have an economy in a tailspin . . . and a company whose performance has not met your expectations or mine," he told shareholders. "I share your concern and disappointment and how it has affected your investment in Starbucks. I promise you that it won't stand."

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#2) On March 19, 2008 at 5:40 PM, floridabuilder2 (99.34) wrote:

yea this was good news for me... i got burned getting into SKF right after the fed meeting yesterday only to see the dow make that huge run and then another run this morning.... that is what i love about this market... 3 hours later the dow is going through the floor.... normally when i make a trade that goes against me it takes months to get out at break even if ever..

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#3) On March 19, 2008 at 6:01 PM, devoish (96.49) wrote:

Don't you think that SRS is the safer play here? It seems that Bernanke is determined to throw enough money at the banks to balance their sheets with worthless dollars. Even if it takes 45trillion. and milk is worth $25.00/gallon. Yet to me all of this makes it harder for salaried/hourly people to ever buy all those houses sitting out there.

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#4) On March 19, 2008 at 6:24 PM, alstry (36.13) wrote:

FB,

patience weedhopper.

Devoish:

Not sure what is a safe play here.  What I can tell you is that the banks are now starting to purge their bad debt.  The liquidaton has begun in earnest.  GS and LEH dumping private equity junk at 80 cents on the dollar.

I side with the likes of Roubini on this one....the only outcome is a systematic meltdown ending in a massive restructuring.  In addition, the way things are looking, it might be quicker that many think.

What is crazy about the current environment is that a lot of stock is traded as part of indexes.  Many of the index players think they are "insured" with swaps.  Can you imagine the stampede when they find out the counterparty might not be able to pay off?

Mommy, why are all those men trying to rush out that tiny door?

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#5) On March 19, 2008 at 6:44 PM, alstry (36.13) wrote:

GET READY FOR THE CROSS DEFAULTS!!!!!!!!!!!!!

From the Updated Bloomberg article:

Hamilton, Bermuda-based SCA, stripped of its AAA bond insurer ratings this year by the three major ratings companies, said last week it was seeking to void the contracts, responsible for $427.4 million of the new reserves for losses set aside last quarter. SCA declined to name the counterparty, which Chief Executive Officer Paul Giordano said on a March 14 conference call failed to meet requirements ``in a fundamental way.''

The complaint says that XL based the assertion on public information from Standard & Poor's that says Armonk, New York- based competitor MBIA has written protection on classes of the CDOs senior to what XL is providing protection on and is the ``sole controlling party'' for the CDOs.

 

THIS IS A MESS AND GETTING MUCH MESSIER.

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#6) On March 19, 2008 at 6:44 PM, devoish (96.49) wrote:

index players think they are "insured" with swaps

Would you explain that a little more? I think I understand what "swaps" are, but not how that insures an index fund, or why anyone would think that it does.

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#7) On March 19, 2008 at 6:47 PM, QualityPicks (24.85) wrote:

Another big step towards the downward spiral. Companies are getting tough on each other. This will force them to recognize their losses and problems. Like I've said, homebuilders, banks, monolines, etc. are all pretending the problem will be solved soon, and are trying to not "make the problem worse" by demanding they get paid back. Everytime somebody demands to get paid, a cascade of problems occur.

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#8) On March 19, 2008 at 6:53 PM, nuf2bdangrus (< 20) wrote:

This is big.  Ironically, I covered all my shorts Friday, and reshorted during the selloff post rate cut...and  not enough shorting there.  Holding SDS as only short.  Counterparty risk is finally coming to roost, and this could be the "black swan" event that may be approaching.  Sentiment turned strongly bullish yesterday, under the false pretense that the Fed will fix everything as a backstop.  They're not even close enough to having the liquidity to make a difference, and they are running out of bullets.  We see how long that sentiment lasted.

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#9) On March 19, 2008 at 8:13 PM, alstry (36.13) wrote:

Dev:

From Wikipedia:

Derivatives such as credit default swaps also create major distortions in the traditional indicators of value of stock and bond markets. Many people wonder why indices like the Dow Jones Industrial Average and S&P 500 seem to go up endlessly. Part of the reason is that big institutional investors no longer sell companies they feel are about to fail, no matter how obvious that impending failure may be. The securities issued by such companies may retain significant paper value up until almost the very end. Instead of selling, investors can buy "insurance" in the form of derivatives and keep holding their investments. This distorts the value of traditional market indices because the decision to remove a failing company from the index can be made well before the paper value drops to zero. This saves the value of the index. It creates the false impression that the index always rises. The underlying markets, for which the index was developed to reflect value, may be far more unstable than appearances indicate. False appearances of stability allow securities markets to appear far less risky than they really are, encourage less knowledgeable players to speculate on derivatives, and allow broker/dealers, financial journalists and some academics to claim that markets are far better investments for the retail investor than they really are. The overall effect is to reduce the perception of risk even though the risk still exists. The reduced perception, however, reduces risk premiums and encourages shoddy loan practices, and may be the cause of runaway financial bubbles, when irrational exuberance gains traction on the basis of inaccurate information.

 

Today, index/etf trading makes up a much greater  percentage of shares traded then just a few years back.

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#10) On March 19, 2008 at 8:22 PM, alstry (36.13) wrote:

Dev:

From Wikipedia:

Derivatives such as credit default swaps also create major distortions in the traditional indicators of value of stock and bond markets. Many people wonder why indices like the Dow Jones Industrial Average and S&P 500 seem to go up endlessly. Part of the reason is that big institutional investors no longer sell companies they feel are about to fail, no matter how obvious that impending failure may be. The securities issued by such companies may retain significant paper value up until almost the very end. Instead of selling, investors can buy "insurance" in the form of derivatives and keep holding their investments. This distorts the value of traditional market indices because the decision to remove a failing company from the index can be made well before the paper value drops to zero. This saves the value of the index. It creates the false impression that the index always rises. The underlying markets, for which the index was developed to reflect value, may be far more unstable than appearances indicate. False appearances of stability allow securities markets to appear far less risky than they really are, encourage less knowledgeable players to speculate on derivatives, and allow broker/dealers, financial journalists and some academics to claim that markets are far better investments for the retail investor than they really are. The overall effect is to reduce the perception of risk even though the risk still exists. The reduced perception, however, reduces risk premiums and encourages shoddy loan practices, and may be the cause of runaway financial bubbles, when irrational exuberance gains traction on the basis of inaccurate information.

 

Today, index/etf trading makes up a much greater  percentage of shares traded then just a few years back.

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#11) On March 19, 2008 at 8:54 PM, abitare (41.44) wrote:

FYI- Some other issues:
If you own an Investment Bank or Bank, I would avoid these

Look at the level of derevatives in these banks.

JPM $91 TRILLION in derevatives

C $34 TRILLION in  in derevatives

BAC $31 TRILLION in derevatives 

W $5 TRILLION in derevatives 

To big to fail? We will see... to big to rescue makes more sense to me. Report this comment
#12) On March 19, 2008 at 10:26 PM, devoish (96.49) wrote:

Alstry,

Thanks.

Abit, according to your chart approximately 80% of the banks value is notional (imaginary). Is that a fair thng to say?

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