Matterhorn Asset Management

Credit Insurers

by Egon von Greyerz

It is Friday before Christmas and most people have already started the holiday celebrations. We normally don’t send out frequent reports especially not in Late December but the dominos are falling so rapidly that we feel obliged to avert investors.

The bond insurers are now officially in trouble. ACA Capital has lost $ 1.1. billion in the recent quarter and has only $ 1.1 billion in cash for future claims. There are more losses in the pipeline. ACA has now lost its AAA rating and been downgraded to CCC (a twelve rating downgrade). Due to the rating downgrade they now need $ 1.7 billion in new capital to fulfil their guarantee obligations of $ 61 billion. No one has offered them more capital so the only saviour would be the government by printing more money. But they haven’t offered either.

The biggest credit insurers MBIA and Ambac are on a credit watch list by the credit rating agencies and so are many other credit insurers. They will most certainly be downgraded too. The total bond value insured by these companies is in the $ trillion.

The reason why this rating downgrade is extremely significant is that banks that have bought the insurance against their bond portfolio can no longer value their investment at par nor can they keep the investment off balance sheet which they have so far. Thus the effect of the credit rating downgrade will necessitate banks to make substantial write-downs of their bonds of potentially $400-500 billion. This is more than the banks can handle and would have catastrophic consequences.

So what started as a liquidity crisis is now a solvency crisis of the banking system. No wonder central banks have injected or printed over $ 1 trillion in the last few weeks. But this has made no difference since the banks that are borrowing the money from the central banks are not lending it on to where it is needed.

Can this situation be remedied? Only by government printing more money in order to take equity stakes in credit insurance companies and banks. Since governments don’t have any surplus money this would be no better than monopoly money and thus highly inflationary. What if they don’t? Well then the financial system could be in an acute crisis which could lead to a severe deflationary downturn.

Whether we first get hyperinflation/stagflation (which eventually leads to deflation) or a deflationary downturn straight away they will both lead to economic turmoil. We know of no other investment than physical gold stored outside the banking system that will protect investors against both these eventualities and also potentially appreciate substantially.