Median housing prices in county hit 4-year low

By Roger Showley UNION-TRIBUNE STAFF WRITER February 13, 2008 San Diego County median home prices fell last month to their lowest level in four years with nearly half of existing homes selling at a loss in the face of mounting foreclosures, DataQuick Information Systems reported yesterday. With most buyers and sellers sitting on the sidelines, distressed properties dominated the market in sales and prices. “Sales overall are ridiculously low,” said DataQuick analyst Andrew LePage. “A larger chunk of what's selling today is in the hardest-hit areas, with more foreclosure activity and depreciation.” LePage said a record 34 percent of resale homes last month were previously in foreclosure and 9 percent were in default. Nearly half of all resale houses and condominiums were sold at a loss from when they were last purchased. The median loss was about 25 percent. By comparison, 5.3 percent of resales in January 2007 had been in foreclosure. The December figure was 31.2 percent. Things could get worse, LePage said, if San Diego slips into recession and homeowners who lose their jobs are forced to sell because they can't make their mortgage payments. “There's an awful lot of uncertainty,” he said, and households are so financially strapped that many will have difficulty keeping above water. Robert Brown, an economist at Cal State San Marcos, called the latest figures “staggering” and said they might feed on buyers' and sellers' expectations of worse conditions to come. “I just don't think this has sorted itself out for sure,” Brown said. “So much of this is speculation, trying to predict what will happen in the future.” The overall median price slipped $1,000 from December and $43,000 from a year ago to $429,000, the lowest since February 2004. The median price for resale houses, making up about half of the market, fell faster, down $18,500 from December and $88,500 from January 2007 to $451,500. The median for resale condos dropped to $300,000, the lowest since November 2003, from $311,000 in December and $380,000 in January 2007. The only bright sign was in the category of new homes. Its $540,250 median was up from $445,000 in December and $395,000 a year ago, reflecting the absence of low-cost condo conversions and the continuing sales of new homes, albeit at low rates. The sale of 1,826 houses last month, the second lowest since DataQuick began tracking San Diego housing in 1988, was 34.1 percent lower than year-ago levels. It was the 43rd straight month that sales dropped on a year-over-year basis. Active listings yesterday stood at 18,443, up from 17,882 in December and 16,689 in February 2007, the San Diego Association of Realtors said. East County and South County neighborhoods have seen the most concentrations of foreclosures and defaults and their overall median price declines reflected that impact – down 20.3 percent and 15.8 percent, respectively. Central San Diego was up 6.4 percent, North County Inland was down 10.8 percent, and North County Coastal was down 9.4 percent. Countering the gloom, area real estate agents and mortgage brokers said they were encouraged by Congress' approval of an economic stimulus package last week. One of its provisions will temporarily raise the conforming loan limit from $417,000 to a projected $630,000 for the San Diego area. That means buyers and owners will be able to take advantage of lower interest rates and better terms not found in jumbo mortgage loans exceeding $417,000. Lori Staehling, president of the San Diego Association of Realtors, said agents and lenders are reporting increasing interest from prospective buyers, as measured by prequalification loan applications and traffic at open houses and new-home subdivisions. Gary West, 60, had applied to refinance his $450,000 loan on a 1,700-square-foot home he has owned in Scripps Ranch since 1972. But now West hopes to rewrite his application to take advantage of the higher loan limit. He also thinks he'll put his house on the market this summer, having failed to sell it in the past year. “You have to wait for the golden goose to come around,” West said. “OK, now we can do it.” Bruce Oberhand, 40, may just be the ideal buyer. Oberhand and his wife, Jenny, and two children live in Aliso Viejo in Orange County and want to relocate to Scripps Ranch, Poway or another San Diego community known for good schools and nice neighborhoods. They have been unable to sell their home, listed at $629,000 to $659,000. “Hopefully, we're buying at a dip and can enjoy the appreciation,” he said. Home builders, who have delayed or canceled new phases and projects, also plan to take advantage of the stimulus package. John Laing Homes, with six subdivisions in San Diego, is launching a buy-now program today. It includes an interest buy-down program as well as better mortgage terms in anticipation of the higher loan limits that won't become effective until early next month. “There's been very positive reaction,” said spokeswoman Linda Mamet. “Buyer traffic has increased 40 percent since the beginning of the year. A lot of that is because of discussions of the economic stimulus package and the anticipated loan limits.” But optimism is not universal. Ramsey Su, a veteran real estate agent who specialized in the foreclosure market starting in the early 1980s, said the market shows no sign of improving. Su said that in parts of Florida foreclosures are outnumbering regular sales. “I've never experienced that before,” Su said. “How does it end? The end is coming in the future.” Paul Leonard at the Center for Responsible Lending noted that the stimulus package may help owners worried about loans that will reset to higher rates but not those already in default or foreclosure. “I suspect it will help some of them but it certainly is not going to be a panacea,” Leonard said. Steve Blank, senior resident fellow in real estate finance at the Urban Land Institute, said 2008 promises to be a “tough year.” “Clearly, we all agree housing got ahead of itself,” Blank said, adding that housing is likely to fall back 5 percent to 10 percent, depending on the market. In San Diego County, the latest median is 17.1 percent off the peak of $517,500 set in November 2005. The single-family-resale median is 21.3 percent off the $574,000 peak set in May 2006.

MBIA blames the short sellers

MBIA vs. Shorts: They’re Kidding, Right?

I had to do a double-take when I saw a Reuters story earlier today that said MBIA planned to urge lawmakers at a Congressional committee hearing Thursday to curtail “the unscrupulous and dangerous market manipulation of short-sellers.”

Memo to MBIA: Take a number and get in line. The bond insurer is the latest in a long list of companies that, over the years, have pleaded with the government to do something — anything — about those dastardly short-sellers who have dared raise red flags over their precious companies.

That’s right: They should tar-and-feather the likes of Bill Ackman of Pershing Square Capital, the most vocal bear on MBIA, who had the audacity to very publicly write a 60-page paper in December 2002 headlined, “Is MBIA Triple A?”. They should further tar-and-feather the guy, and those like him, for taking the other side of the bullish bet on company’s like MBIA — and telling the world they’re doing so — because of their conviction and willingness to warn others about what they believe is looming trouble. (Funny, nobody ever complains about “dangerous market manipulation of longs,” but I digress…) And they should tar-and feather the guy for being right and pretty much forecasting what has happened.

It was, after all, in that paper five years ago that Ackman started warning about the very kind of collateralized debt obligations that have landed MBIA in hot water and, as Ackman suggested at the time, put its Triple-A rating at risk. “In the 1990s,” he explained at the time, “MBIA expanded its risk tolerance and guarantee portfolio to include domestic and global structured fianance guarantees on asset classes including subprime home equity mortgages…” This, of course, was back when nobody cared about anything having to do with subprime or any kind of asset-backed acronym.

At the same time Ackman also was first to point out that MBIA had engaged in a questionable transaction that, in effect, involved insuring a loss after the loss and then collecting on the insurance. (I wrote about it several times; nobody gave a hoot.) The issue, which strikes to the heart of the company’s culture, prompted an investigation by regulators; MBIA settled the civil securities fraud charges last year by paying $75 million.

So, here we are, five years after Ackman first surfaced on MBIA. The ratings agencies have downgraded thousands of CDOs. Thousand of others have been put on credit watch. MBIA had had to pay that fine for engaging in questionable practices. And its stock has been crushed.

Now, rather than accept the reality that it caused its own problems with bad business and actuarial decisions, MBIA is complaining to Congress about the guy who blew the whistle.

Seems that rather than crucify him, they should give him the Congressional Medal of Honor. Okay, that’s a little over the top. But you get the point. And, besides, I’m sure investors who heeded Ackman’s warnings in a free market that encourages a free-exchange of ideas think he deserves one.

P.S.: Don’t be surprised if anti-naked-shorting bandwagon somehow latches itself onto this, blurs the line between legal and illegal short-selling, and somehow blames the naked shorts not only for the fall of MBIA, but for the decline of Western Civilization.

The beat goes on…

Let the finger pointing begin

AP
Bond Insurers to Blame Rating Agencies
Wednesday February 13, 7:04 pm ET Bond Insurers to Put Onus on Rating Agencies for Uncertainty

WASHINGTON (AP) -- The troubled bond insurance industry is being hobbled by uncertainty surrounding the credit rating process, Ambac Financial Group Inc. Chairman Michael A. Callen is expected to tell a U.S. House panel on Thursday.

"Ambac and the industry's next critical step is to restore confidence. This requires stable and predictable credit ratings," Callen says in prepared remarks to be delivered Thursday before the House Financial Services Subcommittee on Capital Markets.

Rival MBIA Inc. in its prepared testimony, takes a harsher tone. The company blames rating agencies for the current market disruption and suggests rating systems "may need to be revamped."

"Instability of decision making by the rating agencies has damaged the market's confidence in the financial guarantors, thereby destabilizing the broader financial markets," the testimony said.

The panel, chaired by Rep. Paul Kanjorski, D-Pa., is set to hear from a variety of industry participants and regulators, including Ambac, MBIA and New York Gov. Eliot Spitzer. At issue is the growing uncertainty surrounding the financial guaranty companies because of their decision to insure various securities backed by troubled mortgage loans.

Expected losses from those securities have raised doubts about the financial health of firms such as Ambac, leading to ratings reviews and downgrades from the major ratings agencies.

Callen said the problems facing bond insurers have been overstated. Ambac, he said, currently has the financial resources to "comfortably meet" all of its existing obligations, even under the most dire market conditions.

"Almost no one questions the ability of Ambac to make good on obligations to holders of Ambac guaranteed debt," Callen said.

Instead, he said the biggest challenge for Ambac is dealing with the uncertainty caused by rating agencies' decision to review their ratings on the company.

"We therefore see the current issues facing the financial guarantors not as a question of ability to meet obligations, but rather a challenge to maintain the stability of ratings that have supported our business in the past and that will support it going forward," Callen said.

MBIA's testimony suggests financial guaranty companies should have a seat at the table in redesigning rating agencies' credit rating systems.

	February 7, 2008

Rescue Plans Won't Prevent Downgrades By KAREN RICHARDSON, LIAM PLEVEN and CARRICK MOLLENKAMP February 7, 2008; Page C1 Rescue plans are starting to take shape for struggling bond insurers, but they aren't likely to prevent further ratings downgrades for many of the companies. At least one such company isn't waiting around. In an effort to raise capital, MBIA Inc. yesterday said it would issue $750 million of common stock, a bigger offering than the $500 million issue it had initially planned. The company also said it will revise its fourth-quarter loss of $2.3 billion, cutting it by $65 million. MBIA also added $100 million to its loss reserve, bringing the total special addition to $200 million. Still, some banks and investors working toward salvaging the bond insurers, which guarantee the interest and principal in the event of default, are realizing that even the best plans could require them to settle for less -- less risk, less reward and bond insurers with less-than-triple-A ratings in the future, according to several people familiar with the rescue talks. A group of banks -- betting that the insurers still have some value -- are working with the management and investors of New York-based Financial Guaranty Insurance Co. on a potential plan for FGIC. They have held a series of meetings and conference calls in recent days. The group, which is led by Calyon, a unit of French bank Credit Agricole SA, includes UBS AG, Société Générale SA, Citigroup Inc., and Barclays PLC. A Calyon spokeswoman declined to comment. The banks are trying to figure out how to commute, or unwind, their credit-default swaps, which are contracts they entered into with FGIC and other bond insurers to guarantee their portfolios of complex debt securities known as collateralized-debt obligations, or CDOs, according to people familiar with the talks. A consortium of banks working toward a rescue plan for bond-insurer Ambac Financial Group Inc. also is discussing a similar option, according to people familiar with the matter. In exchange for unwinding the contracts, FGIC and Ambac could give the banks stakes in their companies through warrants, according to these people. The banks, then, would share in the proceeds that the bond insurers would make as they collect premiums and wait for their existing portfolio of policies to expire, or "run off." In this scenario, the most the banks are hoping for is that the bond insurers' credit ratings don't fall below double-A, but they aren't getting their hopes up for a return to triple-A glory, according to two of the people. "There's run-off value as you get rid of the toxic elements of these companies through commutations," says David Havens, an analyst at UBS Securities, who isn't involved in any of the bailout talks. "Only about 5% of the business is problematic, and 95% is fine." Ambac, FGIC and rivals MBIA, Security Capital Assurance Ltd. and CIFG Holding Ltd. are exposed to about $100 billion in CDOs that were backed by rapidly deteriorating subprime mortgage collateral, according to Fitch Ratings. Some analysts estimate that sharp downgrades of these bond insurers, or their insolvency, could cause banks to write down as much as $70 billion. In late December, for example, Calyon said €1.2 billion ($1.75 billion) in its write-downs was tied to bond insurers, mainly ACA Financial Guaranty Corp., which was downgraded to triple-C from single-A. By unwinding the credit-default swaps, the banks would enable the bond insurers to free up capital, which they could use to help preserve their ratings or help prevent further downgrades. Of about $315 billion in debt that FGIC had insured through to Sept. 30, 2007, about $31 billion was backed by mortgage collateral and $8 billion was backed by subprime mortgages, according to an FGIC presentation. Ambac has about $67 billion in CDO exposure. Spokesmen for FGIC didn't respond to calls to comment, and a spokesman for Ambac declined to comment. Most of the bond insurers in the industry are under threat of losing their high-level ratings as the mortgage crisis increases the likelihood that they will have to pay out claims with limited access to capital. Fitch, for example, says it is possible that the majority of bond insurers won't continue to have triple-A ratings in the future. "It's just an indeterminable amount of losses on these assets and the final number could be far more significant that we had been envisioning," Thomas Abruzzo, managing director at Fitch, says. Last month, Fitch and Standard & Poor's downgraded FGIC to double-A from triple-A. Fitch also downgraded Ambac to double-A. A key hurdle for the banks and the bond insurers is determining how much the banks should get in exchange for tearing up their credit-default swaps, and whether owning stakes in companies that could get further downgraded is fair compensation, says one person familiar with the discussions. Another option being bandied about by analysts and others is to form a new company, funded by the banks, which could take responsibility for meeting the obligations of some of the insurance policies -- mainly the credit-default contracts -- weighing on the bond insurers. This model would have the added benefit of enabling banks to unwind some of their credit-default swaps with the other beleaguered bond insurers, and guarantee their debt with the new, triple-A-rated bond insurer. But there are potential downsides, too. Banks might be choosy about which risks they would be willing to let the new insurer take on, and that could mean bond insurers might be left with the high-risk business, Steve Stelmach, an analyst at Friedman, Billings, Ramsey & Co. noted in a recent research note.

Close

Oldie but Goodie

Moody's admits they suck

	February 5, 2008

Moody's Weighs Warning Labels For Its Ratings By AARON LUCCHETTI February 5, 2008; Page C1 In an acknowledgment that the system it used to rate billions of dollars of mortgage-related securities was potentially flawed, Moody's Corp. said it is considering a new way of rating those and other sometimes-volatile structured finance vehicles. The credit-rating firm is considering an overhaul of its rating procedures that could include new labels to help investors distinguish collateralized debt obligations and other structured-finance investments from corporate bonds and Treasury securities. One of the most significant changes being considered by the parent of Moody's Investors Service: a new, 21-point numerical scale to rate structured securities. Moody's familiar letter grades -- from triple-A to single-C -- would continue to be used for corporate and government bonds, including tax-exempt municipal debt. More broadly, the ratings firm is trying to decide whether to add warning labels that essentially acknowledge the limitations of its ratings. "We've been taking a hard look at the things we do," said Richard Cantor, a managing director at Moody's who co-wrote the four-page report released yesterday in which the ratings firm announced the possible changes. This is the first time since the methodologies of Moody's and rival credit-rating firms came under attack this past summer that any of the firms has suggested it might change how it issues its hugely important ratings. The move also is an indirect admission that Moody's ratings didn't work right, even though the firm still insists some investors relied on them too much. Standard & Poor's, a unit of McGraw-Hill Cos., said it is working on similar moves to shore up confidence in its ratings, though a spokesman declined to discuss details. A spokesman for Fimalac SA's Fitch Ratings said: "We're constantly looking to make sure our ratings are as productive as possible for investors." The possible changes also show how Moody's is trying to rehabilitate its reputation while heading off more draconian changes that could be forced on credit-rating firms by lawmakers and regulators fuming over mortgage-bond downgrades criticized as too little, too late. Those downgrades helped exacerbate the credit markets' woes in recent months. Regulators in Europe and the U.S. may welcome any change by Moody's. Federal regulators, led by the Securities and Exchange Commission, may even propose in coming months that certain distinctions be made for all structured finance ratings, according to a person familiar with the matter. If Moody's goes through with any of the changes, investors are likely to tread more carefully before buying structured finance vehicles. That could reduce demand for such securities. But some Wall Street experts said the ratings firms should focus on doing a better job with the current system. Lawyers Rule? "This sounds like what a lawyer is telling them to do, rather than giving investors valuable information," said Thomas Atteberry, a fund manager at First Pacific Advisors. "If you're going to put a bunch of warning labels on the rating, I'm going to say, 'What is the value there?"' Historically, Moody's has defended the idea of having the same letter-based approach for all the bonds it rates, saying investors prefer that approach. Recently, though, some investors have expressed interest in a separate ratings methodology for mortgage-related bonds, since they have proven to move in packs and to be prone to multinotch downgrades that indicate a rapid change in the overall view of their creditworthiness. Moody's said some sophisticated bond-fund managers don't think it would be useful to have a different rating approach for structured finance. But those managers' clients -- pension funds and wealthy individuals -- have been concerned that some triple-A bonds act so differently from others. Moody's said recently it has downgraded 252 triple-A ratings for CDOs sold in 2006 and 2007, or 22% of the 1,155 deals issued in that period. The average magnitude of downgrade was about eight notches. Standard & Poor's has lowered its triple-A rating on 274 mortgage-related bonds and investments, or about 6.7% of the ratings it gave to these instruments issued from 2005 to the third quarter of 2007. More than 60 of these have been downgraded 10 or more notches to junk status, including Bear Stearns Mortgage Funding Trust 2006-SL1 and Home Equity Mortgage Trust 2006-5 in December. Many of the downgraded mortgage deals have plummeted in value, leading to billions of dollars in write-offs for financial firms. Playing Scales In its report, Moody's said a "different rating scale for structured securities could provide greater clarity about differences" between types of bonds "and could encourage market participants to consider the potentially different characteristics of structured and nonstructured securities" in designing their portfolios. In addition to using a new rating scale, Moody's also suggested the possibility of adding extra labels or warnings to ratings to indicate subtleties in the way mortgage bonds and other structured vehicles perform. This could include an "SF" designation after a rating or an extra volatility rating, such as "v2." "It would be a heads up for the investor that they might want to look more closely, view the product differently and make sure they're comfortable with the way they're treating it," Mr. Cantor said. Moody's is open to carrying out any of the five options outlined in its letter, though no decision will be made until the firm hears what investors think, he added. Moody's has attempted some industry overhaul in light of the mortgage market's problems. In the fall, it called for better due diligence in the mortgage-underwriting process. Moody's previous calls for change haven't resulted in dramatic action, in part because the firm was making recommendations on how others in the mortgage industry conducted themselves. A spokesman said dialogue with the industry continues on those topics. Moody's has more direct input over these new issues because they deal with its own rating process. At the very least, Moody's will publish papers that warn investors about the unique performance features of mortgage bonds. "Moody's doesn't believe the status quo is acceptable," Mr. Cantor said. "We're doing all we can to improve our methodologies."

Close

MBIA's marathon (negative) earnings call

You can read the full transcript here.

Banks to MBIA: You're on your own

Bank losses from monolines likely $5-7 bln: analyst

Mon Feb 4, 2008 1:33pm EST

NEW YORK (Reuters) - Financial institutions are likely to take only around $5 billion to $7 billion in losses from their exposure to bond insurers, while a bailout of the industry by banks is unlikely, Morgan Stanley said on Monday.

Monoline bond insurers are under review to lose the "AAA" ratings vital to their business, as their capital is not viewed by rating agencies as adequate due to losses they are expected to take from insuring risky residential mortgages.

Some analysts have said they believe U.S. financial institutions exposed to the bond insurers are facing as much as $50 billion to $70 billion in losses, though Greg Peters, Morgan Stanley's lead credit analyst, said he views exposures as significantly lower.
"That (number) seems too high to us to begin with and that is a gross number," he said on Monday on a conference call.

Morgan Stanley evaluated mortgage exposure in Collateralized Debt Obligations (CDOs) insured by the bond insurance arms of Ambac Financial Group Inc (ABK.N: Quote, Profile, Research), FGIC, Security Capital Assurance (SCA.N: Quote, Profile, Research), and MBIA Inc (MBI.N: Quote, Profile, Research), and determined that exposures by U.S. banks is likely in the $20 billion to $25 billion range.

Once the capacity of the bond insurers to pay out claims is taken into account, and assuming that a bankruptcy doesn't force the insurance arms of the companies out of business, likely losses are in the $5 billion to $7 billion range, Peters said.

Bond insurers typically have holding companies, which issue stock and debt, while the insurance arm generates the income that pays dividends on the stock.
"These are very complex structures...very little in the way of investors really understand the dynamics of these structures," Peters said.

While the inability of an insurer to generate new business could weigh on the holding company, and potentially drive the stock price down to zero, the insurance arms could continue to operate on its existing business, and continue to pay claims, he said.
In this scenario, the counterparty exposure of banks to the insurers is negligible, he added.

DOWNGRADES, NEW ENTRANTS

Meanwhile Morgan Stanley continues to view a downgrade of MBIA or Ambac as likely, in spite of talks between banks and the New York insurance regulator for a bailout of the industry.
"We believe there will be downgrades, absolutely," Peters said. "A LTCM style kind of bailout is pretty remote."

Hedge fund Long Term Capital Management (LTCM) was bailed out by a consortium of banks in 1998 after it faced margin calls on heavily levered exposures to U.S. government bonds and emerging market debt.

"We just don't think the incentives exist, banks are clearly capital constrained, the exposure to the monolines is far from uniform, so one dealer might not want to help out their competitor when they have a very limited exposure," Peters said.

"I think the key difference is, unlike LTCM, these losses are not temporary," he said. "They're real losses, the ABS CDO losses are real and will actually be taken at some point in time, unlike the temporary kind of liquidity phenomenon of 1998...you're actually asking banks and dealers to pony up cash to help plug a loss that's far from temporary."

Meanwhile, Financial Security Assurance (FSA), Assured Guaranty Corp (AGO), whose "AAA" ratings are not under review, and the new market entrant created by Warren Buffett's Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research) (BRKb.N: Quote, Profile, Research), will likely be sufficient to satisfy market needs for bond insurance, Peters added.

"You don't need to have an Ambac still in business, you've got the FSA, AGO and Berkshire Hathaway...they can come in and write new business," Peters said. "So we're not convinced that you need to have existing monolines still up and running as you have other ways that you could actually wrap that risk."

Look out below!

Moody's Adjusts CDO Loss Assumptions

Moody's Investors Service Alters Its Expected Loss Assumptions for CDOs Originated in 2006

NEW YORK (AP) -- Credit rating agency Moody's Investors Service said Monday it revised its loss assumptions for collateralized debt obligations originated in 2006.
So-called CDOs are complex financial instruments that combine slices of debt and are sold to investors. Many CDOs are backed by mortgages, especially subprime mortgages given to customers with poor credit history.
As those mortgages have increasingly defaulted in recent months, ratings agencies have worried the CDOs will also default. That has also forced banks to reduce the value of the securities.
Moody's said it will use the new loss assumptions when reviewing CDO ratings on deals originated in 2006.
Shares of Moody's fell 43 cents to $35.55 in afternoon trading.

MBIA: you're on your own

Setback for monoline rescue
Financial Times
By Henny Sender and Aline van Duyn in New York
Sunday Feb 3 2008 17:10

Leading private equity firms are unlikely to participate in any recapitalisation of Ambac and MBIA (NYSE:MBI) , increasing the pressure on banks to come up with a rescue package for the troubled US bond insurers.

A number of firms, including Bain Capital, Carlyle Group, Kohlberg Kravis & Roberts and TPG, have looked at investing in the cash-strapped groups, which guarantee the value of everything from municipal bonds to the most complicated mortgage securities. These investors have all concluded that the risks are far too great, according to people familiar with their thinking.

The decision puts more pressure on the banks to provide rescue financing for Ambac and MBIA. Some large banks and securities firms could face large writedowns on mortgage securities, as well as derivatives, if the bond insurers lose their triple-A credit ratings.

A group of eight banks is already considering a plan to inject capital into Ambac, which needs at least $1bn. Several banks are also believed to be talking to MBIA, which needs at least $500m. It is likely that any solutions, which are also a top priority for regulators, will be crafted for each bond insurer, rather than as a general bail-out.

The reluctance of big private equity firms to become involved comes after all have looked closely at the two major monolines. They have also studied the experience of Warburg Pincus, which committed $1bn to MBIA in early December at what seemed an attractive price, only to see MBIA's share go into freefall. Additionally, they have noted that Blackstone, which has a minority stake in FGIC, has so far declined to put more money into that troubled bond insurer.

"If we worry that we can get shot from the shadows by something we can't see coming, it is not for us," says the managing director in charge of financial service investments for one of the leading private equity funds. "The financial guarantors pass neither the shadow test nor the ability to understand test."

The next two to four weeks will be vital for the bond insurers because the biggest ratings agencies have made it clear they are very close to cutting their ratings. Fitch, a smaller ratings agency, has already cut the triple-A ratings of Ambac and FGIC. Moody's Investors Service and Standard & Poor's have both said they are considering ratings cuts for Ambac and MBIA.

Hello year 2000 prices.

Housing Meltdown

Why home prices could drop 25% more on average before the market finally hits bottom

by Peter Coy

As Washington policymakers struggle to keep the U.S. out of recession, the swirling confusion over the housing market is making their job a lot tougher. Will American consumers keep shopping or be forced to pull back? Will banks lend freely or be hamstrung by mortgage defaults? What are the best policy options right now? Those and other important questions simply can't be answered without a good idea of whether home prices will rise, flatten out, or keep dropping.

Some experts have begun to suggest that a bottom is in sight. Pali Research analyst Stephen East wrote in a research note to his firm's clients on Jan. 25 that "the sun is not shining very brightly, but at least the worst of the storm has likely passed." With optimism budding, Standard & Poor's beaten-down index of homebuilder stocks soared 49% from Jan. 15 through Jan. 29.

But it's considerably more likely that the storm is still gathering force. On Jan. 30 the government said annual economic growth slowed to just 0.6% in the fourth quarter as home construction plunged at a 24% annual rate. The Standard & Poor's/Case-Shiller 20-city home price index fell 7.7% in November from the year before, the biggest decline since the index was created in 2000.

And that could be just the start. Brace yourself: Home prices could sink an additional 25% over the next two or three years, returning values to their 2000 levels in inflation-adjusted terms. That's even with the Federal Reserve's half-percentage-point rate cut on Jan. 30

While a 25% decline is unprecedented in modern times, some economists are beginning to talk about it. "We now see potential for another 25% to 30% downside over the next two years," says David A. Rosenberg, North American economist for Merrill Lynch (MER), who until recently had expected a much smaller slide.

Shocking though it might seem, a decline of 25% from here would merely reverse the market's spectacular appreciation during the boom. It would put the national price level right back on its long-term growth trend line, a surprisingly modest 0.4% a year after inflation. There's a recent model for this kind of return to normalcy after the bursting of a financial bubble. The stock market decline that began in 2000 erased most of the gains of the boom of the second half of the 1990s, leaving investors with ordinary-sized returns.

Why might housing prices plunge violently from here? Remember the two powerful forces that pushed them up: lax lending standards and the conviction that housing is a fail-safe investment. Now both are working in reverse, depressing demand for housing faster than homebuilders can rein in supply. By reinstituting safeguards such as down payments and proof of income, lenders have disqualified thousands of potential buyers. And many people who do qualify have lost the desire to buy. "A down market is getting baked into expectations," says Chris Flanagan, head of research in JPMorgan Chase's (JPM) asset-backed securities group. "People say: I'm not buying until prices are lower.'" He predicts prices will fall about 25%, bottoming in 2010.

Nobody can be sure how far prices will decline. Still, if prices drop that much, it could mean big trouble for the U.S. economy, which is already on the brink of recession. It would blow a hole in the balance sheets of banks and households, slicing more than $5 trillion off household wealth. That's roughly the size of the drop in stock market wealth from the peak in early 2000, a big reason for the recession of 2001. Yale economist Robert J. Shiller, a longtime housing bear, points out that a housing decline that started in 1925 and ran until 1932 weakened banks and contributed to the Great Depression, which started in the U.S. in 1929.

MACARONI AND CHEESE

It has become a cliché, but an accurate one, that Americans used their homes as ATMs during the boom years. They lined up for cash-out refis or home-equity loans to turn housing wealth into spending money. So far, the amount of equity being withdrawn has remained surprisingly strong—$700 billion at an annual rate in the third quarter. But it's bound to dwindle if prices keep falling, giving the economy a further downward push. According to an analysis conducted for BusinessWeek by Zillow.com, the real estate Web site, a further 20% decline in prices nationwide would mean that two-thirds of people who bought in the past year would owe more than their homes would be worth, meaning they couldn't take out cash if they wanted to.

Alesandra Sanchez, who works for the city of Las Vegas, and her husband, Craig Mireles, a project manager for an architect, are living that problem. Their house in Summerlin, Nev., has quickly gone from a money geyser to a drain. The couple raised about $70,000 in cash in 2005 by refinancing less than a year after they bought their home. They put the money toward student loans, medicine for Sanchez's rheumatoid arthritis, and other things. Now the cash is gone and the interest rate has ratcheted up to 11%. Alesandra says the new payment of $4,200 a month "is doablebut it's like eating macaroni and cheese: It doesn't leave room for anything else." No wonder that retail sales fell 0.4% in December, and economists are projecting a sharp slowdown in overall consumer spending this year.

The second shock to the economy from the housing bust will come from the financial sector, which has been weakened by losses on mortgages as well as mortgage-backed securities and more exotic derivatives. Banks borrow so much money to fund their investments that if a loss on some holding reduces their capital by $10, they have to reduce their lending by $100 to avoid exceeding their self-chosen leverage targets, calculates Goldman Sachs (GS) chief U.S. economist Jan Hatzius. He estimates that banks and other financial institutions will suffer about $200 billion in real estate losses and respond by cutting their lending by $2 trillion, or about 5% of total lending. The cutback could be even more extreme if they react to the turmoil by lowering their leverage ratios, he says, rather than keeping them intact. Banks have already begun tightening lending standards. In the third quarter, mortgages were harder to get than at any time in the 17-year history of the Federal Reserve's survey of senior loan officers.

Prices won't fall uniformly, of course. Once-booming cities such as Las Vegas and Miami and weak economies like Detroit are likely to fare worse than Seattle or Charlotte, N.C. The price decline will be smaller if it's stretched out over longer than, say, two years, because inflation will have more time to do some of the job of eroding the real value of homes. Still, if the national average decline is anywhere near 25%, the entire U.S. economy is in for trouble. Keep in mind, says Merrill's Rosenberg, that the relatively puny price decline to date has already pushed home-loan delinquencies to their highest level in 20 years. The plunge in residential construction reduced the economy's annual growth rate by a full percentage point in the third quarter of 2007. A bigger decrease would wipe out even more jobs—carpenters, real estate agents, mortgage brokers, furniture salespeople.

For American consumers, meanwhile, huge losses would almost certainly undermine the long-held premise that homeownership is the most reliable way to build wealth and a middle-class life. "I know you're not supposed to say I told you so,' but I'm at the age where I can do it: Homeownership was oversold," says 67-year-old House Finance Committee Chairman Barney Frank (D-Mass.).

One look at the long-term home price chart tells you all you need to know: Starting in 2000, prices crossed above their trend line and just kept going up. The spike had never happened in modern U.S. history, according to data dating back to 1890 that Shiller painstakingly compiled for the second edition of his book Irrational Exuberance in 2005. Back then he predicted a sharp drop in house prices. Now he says lawyers won't let him publicly forecast home prices because he's involved in preparing the market-sensitive Standard & Poor's/Case-Shiller home price indexes. All he'll say is: "This is a historic turning point."

Optimists point out that the Fed, Congress, and the White House are all committed to keeping housing aloft so it doesn't kill the economy. The Fed reduced the federal funds rate by three quarters of a percentage point on Jan. 22 and followed with a half-point cut on Jan. 30—an extremely rapid move for a major central bank. Homebuilders also are doing their bit to support prices: They've cut production so drastically that even though home sales fell more than expected in December, the backlog of unsold new homes shrank slightly. Douglas Duncan, chief economist of the Mortgage Bankers Assn., predicts existing home prices will slip less than 2% this year before beginning to rebound in 2009.

Pessimists aren't impressed. One of the first high-profile bears on housing, Ian Shepherdson of consulting firm High Frequency Economics, is looking for a 20% decline in prices from their peak but says 40% wouldn't shock him. "We've never been here before, so there's no road map," he says.

There's even uncertainty about where prices are right now, since many would-be sellers are refusing to cut them enough to make a sale. A Harris Interactive (HPOL) survey for Zillow.com in December found that 36% of homeowners thought their homes had increased in value over the past year, vs. 23% who thought they had decreased. That willful optimism translates directly into the record overhang of unsold existing homes: more than 4 million.

For a truer picture of the market, look at sales by banks and builders, which don't have the luxury to wait things out because they have to worry about cash flow. Deutsche Bank (DB), among other banks, has been slashing prices on repossessed homes to get rid of them. In a recent transaction mentioned on BusinessWeek's Hot Property blog, Deutsche Bank sold a house in Woodbridge, Va., in December for $150,000, less than half its last sale price of $315,000 in the spring of 2005. In November, Lennar (LEN), the big builder, sold 11,000 home sites to a joint venture it formed with Morgan Stanley Real Estate for $525 million, 60% below what they were valued on Lennar's books. That's capitulation, and it's likely to occur more often as sellers get the idea that waiting won't solve their problems.

MORTGAGE HURDLES

Plenty of other evidence supports the notion that home prices have further to fall. There's a crisis of confidence in the securitization of mortgages, which pumped up housing demand by giving buyers access to nationwide and even global pools of capital. The loose links in the securitization chain allowed risky loans to be made at low rates. Trust in that system is broken and will not be mended quickly.

Almost the only mortgages being securitized successfully are the ones bought by Fannie Mae (FNM) and Freddie Mac (FRE), the private companies with implicit government backing. They accounted for about 87% of mortgage securitizations in December, vs. fewer than half in 2005 and 2006, according to the publication Inside MBS & ABS and the investment bank UBS (UBS). Subprime lending is nearly shut down, home-equity loans and lines of credit are scarce, and jumbo mortgages (too big for Fannie and Freddie to purchase) command premium rates. A survey of real estate agents found that a third of planned home sales were canceled or delayed last fall because of loan problems.

Even Fannie and Freddie, which style themselves as the last resort of the home buyer, have tightened standards and raised fees. And they remain reluctant to raise funds to buy mortgages if it means lowering returns to shareholders. Fannie Mae Chief Executive Daniel H. Mudd joked to Wall Street analysts in December that the process of cutting the dividend and selling preferred shares to raise money pained him so much that "I wanted to cut off both my arms and both my legs, and my head, and my kidney."

Cheaper mortgages won't necessarily ride to the rescue, either. Thirty-year conventional fixed-rate mortgages failed to fall after the Fed's two January rate cuts, averaging 5.5% on Jan. 30. Financing remains cut off for subprime borrowers (BusinessWeek, 12/11/07) and for owners whose home equity has dipped too low to qualify for a new loan. Fed rate cuts will ease, but not eliminate, the pain from resets on adjustable-rate loans.

For another bearish view, there's what economists refer to as the Mankiw paper. In 1989, long before working in the White House as chief economic adviser or writing his best-selling textbook, Principles of Economics, Harvard University economist N. Gregory Mankiw co-wrote a paper that was startlingly negative on housing. He and David N. Weil predicted that home prices would decline by 47% after inflation over the next 20 years, based on a shrinking pool of potential first-time buyers and an expectation that baby boomers as a group would spend less on housing as they grew older.

It could be that Mankiw and Weil were not so much wrong as premature. Although boomers have thwarted expectations by adding on rooms and second homes as they age, they won't thwart nature. "At some point, death or illness will cause baby boomers' houses to come onto the market," observed John Krainer, a senior economist at the Federal Reserve Bank of San Francisco, in an in-house publication in 2005. When the huge boomer generation shuffles off, the nation's housing needs will wane. That will create an oversupply unless builders see it coming and reduce construction. Judging from the recent overbuilding binge, though, their forecasting abilities leave a lot to be desired.

NECESSARY EVIL

Observers with a Calvinist streak see a housing crash as not only necessary but also positive. It will force Americans to live within their means, which will enable the U.S. to work off some of its towering debt, says Peter D. Schiff, president of Darien (Conn.) brokerage Euro Pacific Capital, who was early in predicting the crash. In 2005 the share of gross domestic product devoted to residential construction reached the highest since 1950, when the U.S. was racing to house the baby boom generation and make up for the lack of construction during the Depression and World War II. Now, says Schiff, "if there's any construction, it's going to be factories, oil exploration, mines." He takes almost unseemly delight in predicting tougher times ahead: "Americans are going to have their credit cards taken away from them by the lenders. We're going to turn the American economy into a cash economy."

Foreclosure counselors such as Mildred Wilkins foresee similar changes, except in looking back they put more of the blame for the fiasco on builders and lenders and less on borrowers. "We have been fed the illusion that acquiring a home was a magic key to stability, to wealth-building," says Wilkins, who travels the country advising lawyers and others on how to handle foreclosures. Even though she is president and founder of an Indianapolis company called Home Ownership Matters, which promotes responsible ownership, Wilkins says she never believed the "poppycock" that homeownership was a sure path to wealth, calling it a myth foisted on lower-income Americans by politicians serving the builders and bankers.

The sense of betrayal is probably most intense among the working-class families who were supposed to be the greatest beneficiaries of easy access to low-down-payment mortgages. The less-pricey outskirts of expensive cities such as Los Angeles and San Francisco are precisely the areas where the biggest share of recent buyers are underwater on their mortgages. Cindy and Larry Chaffold, who live in the desert east of Los Angeles in Apple Valley, bought a house for $216,000 in 2005 that's now appraised at $190,000. Cindy was ready to hand the keys to the bank until she got her loan modified. Says Chaffold: "I have been screwed, chewed up, and spit out."

HARKING BACK TO FDR

If home prices really fall an additional 25%, Washington's rescue program is likely to seem seriously inadequate. So far the Bush Administration is pushing two main ideas: FHASecure, which offers new mortgages to certain well-qualified borrowers, and Hope Now, a private-sector program to streamline the modification of unaffordable loans. But FHASecure isn't open to people who are underwater on their mortgages—in other words, those who most need help. And the Hope Now alliance doesn't seem to be coping successfully with the mounting backlog of loan delinquencies. The other big Washington initiative, to crack down on loose lending practices, could be ineffective and even counterproductive, because it's making loan funding less available right when it's needed most.

The next big reform ideas may hark back to President Franklin D. Roosevelt. Many of the housing market's props today—including Fannie Mae and the Federal Housing Administration—were launched during the 1930s. If things get bad enough, say some analysts, it could raise interest in renewing another innovation of the Depression years, the Home Owners' Loan Corp., which lent money directly to hard-pressed borrowers to prevent foreclosure. If enough banks get into trouble, Congress might even create something roughly parallel to the 1980s-era Resolution Trust Corp., which cleared up the savings and loan crisis by shutting down weak thrifts, thus wiping out the investments of the owners, and then selling off their assets to the highest bidders.

And with homeownership no longer seeming like such a sure thing, national housing policy could become more evenhanded toward renters. Congress is weighing the creation of a National Affordable Housing Trust Fund that would build, rehabilitate, and preserve 1.5 million units of housing for the lowest-income families over the next 10 years. The national homeownership rate has already fallen about one percentage point from its peak, to 68.2% in last year's third quarter.

However things unfold, the changes are likely to be wrenching. The bigger the boom, the harder the fall.

Links

The Good…

Several markets are still booming. In Australia, median prices in Melbourne rose about 25% in 2007 and could surge past higher-priced Sydney within a year, according to a Jan. 26 editorial in Melbourne's Herald Sun. China's Xinhua Financial Network reported on Jan. 24 that property prices in 70 large Chinese cities rose 10.5% in December from the previous year, despite "several directives aimed at squeezing liquidity from the market"—confirming that bubbles aren't easy to pop.

The Bad…

But in other places, price growth is slowing or reversing. BusinessWeek (MHP) reported on Nov. 21 that on the outskirts of Spanish cities "you'll find a forest of half-built apartment towers and townhouses." In Ireland, traditionalists welcome the market's sudden cooling. A Jan. 24 column in the Kildare Nationalist rued the way a construction boom had spoiled the appearance of 800-year-old Athy. "The once-compact market town...has been extended and reshaped almost beyond recognition," the columnist wrote.

…and the Silver Lining

Prices are falling in Britain as well, and to some analysts, that's just fine. On Jan. 28, The Times of London ran a commentary by a geography professor Chris Hamnett titled, "Great news! House prices are down." His point: By making homes more affordable, a big price drop will be good for the market's long-term health.

For more on the housing market swoon, including steps sellers can take to cope with the tough environment, watch a video report at BusinessWeek.com/go/tv/homeprices

Join a debate about the subprime mortgage crisis.

Coy is BusinessWeek's Economics editor.

Next shoe to drop.

Voltron says: option arm recasts will speak in 2009, resets in 2010 and 11 and they will be worse than the subprime losses.

Option ARMs, next chapter in U.S. housing crisis

By Nick Carey

CHICAGO (Reuters) - The U.S. housing crisis has focused attention on adjustable rate mortgages (ARMs) and the danger posed by their spiking interest rates.

But mortgage bankers, industry experts and nonprofit officials say that the impact of one particularly nasty kind of ARM -- called the Option ARM -- involving hundreds of billions of dollars of loans has yet to be felt. And, they say, it will hit prime borrowers and subprime borrowers alike.

People like Bruce Rose, 53, who never should have got a loan.

Rose, 53, bought his home in Boston in 1986. After stress and depression forced him to retire as a state employee in April 2006 he "maxed out" his credit cards on his annual income of around $16,000.

On medication, he refinanced his debts through the largest U.S. mortgage lender, Countrywide Financial Corp. The new loan totaled $439,000. Rose said he did not know his mortgage broker and Countrywide used a stated income loan -- also called a "liar loan" because no proof of income is required -- and that they claimed his monthly income was $12,166.

"If I had known what I was signing I would never have agreed to the loan," he said. "Now I may lose my home."

With an Option ARM, borrowers can make a minimum monthly payment like a credit card, but if they do the principal increases. Rose's minimum payment rose from $1,200 a month to $2,800 and his loan now totals more than $500,000. He is fighting foreclosure.

"No reasonable lender would have given him a loan like that," said Virginia Pratt, a foreclosure prevention counselor at ESAC, a Boston nonprofit group, who is seeking legal counsel for Rose.

Countrywide -- set to be bought by Bank of America and seen by critics as a poster child for excesses leading to the housing crisis -- did not respond to a request for comment.

Rose's is an extreme case, but industry insiders say Option ARMs, also called Payment Option ARMs, will be the next chapter in the U.S. housing crisis and could push hundreds of thousands more subprime and prime borrowers into foreclosure.

"So far the public is largely unaware Option ARMs are going to cause problems," said Scott Stern, Chief Executive of Lenders One Mortgage Cooperative, whose 100 members originate $40 billion in mortgages annually. "But mortgage servicers know what's looming in the pipeline."

Subprime borrowers have weak credit histories, while prime borrowers have good credit. Industry insiders say a skewed system that paid mortgage brokers more to sell Option ARMs than traditional loans has left even prime borrowers struggling with monthly payments and unable to either sell or refinance.

"So far we have only seen the tip of the iceberg of this problem," said Michael Lefevre, CEO of trade group the National Association of Mortgage Professionals (NAMP).

NEGATIVE AMORTIZATION

Option ARMs have existed since the 1980s, but according to a U.S. Federal Deposit Insurance Corporation report, "Outlook Summer 2006," as recently as 2002 they were still quite rare.

Like a normal ARM, the interest rate on one of these loans resets periodically. But the payment option allows you to make a minimum monthly payment instead of the full interest-only payment. The trouble is that the portion you don't pay is added to the principal of the loan, so your mortgage goes up. This process is called negative amortization.

"This product is suitable for people with a lot of money who are financially astute," said David Zugheri, president of First Houston Mortgage, which offers loans in 18 U.S. states. "But very few people fit that category and that's why we didn't make many of these loans."

Unfortunately, many other lenders did.

According to the Fed, in 2005 $1 trillion in new mortgages were issued, with another $1 trillion in 2006. ARMs made up about half of the total, according to the Mortgage Bankers Association (MBA). The MBA said Option ARMs made up 7.2 percent of all home mortgages in 2005 and 14.4 percent in 2006, giving a total of around $210 billion for those two years alone.

"This product has been used by far more borrowers than it was ever intended for," said Brian Chappelle, a partner at mortgage consulting firm Potomac Partners LLC.

U.S. regulators tightened standards on Option ARMs in late 2006 and the number of new loans tailed off.

Until then, many mortgage brokers liked Option ARMs as they netted a far higher commission than a safer, fixed-rate loan.

"If you're a broker and you can get $4,000 commission for a traditional loan and $12,000 commission for an Option ARM, which one are you going to pick?" said NAMP's Lefevre.

Option ARMs also allowed people to buck the system and buy well beyond their means.

"An Option ARM fed the American aspirational mentality and allowed people to get into a home beyond what they could afford," said Joe Dombrowski, an executive consultant at Brookfield, Wisconsin-based Fiserv Lending Solutions. "The minimum payment makes that possible."

The problem is paying for it. According to a December 2006 Fitch Ratings report, almost 90 percent of people who got an Option ARM in 2006 used little or no documentation and more than 90 percent were suffering from negative amortization.

Industry insiders estimate at least 60 percent of Option ARM borrowers make only the minimum monthly payment. A Jan 22 issue of "Mortgage Strategist" a research note from investment bank UBS, estimated up to 80 percent pay the bare minimum.

"If you continue to make the minimum payments, a $600,000 loan can become a $750,000 loan within a couple of years," Fiserv's Dombrowski said. "You may have good credit, but now you're in a trap."

"And because you have good credit and are making your minimum monthly payments," he added, "you're not on anyone's radar screen yet."

STUCK IN A TRAP

Industry insiders say that as long as housing prices continue to rise and selling a house is not a problem, Option ARMs are straightforward to refinance.

"Unfortunately the economic conditions are working against a lot of borrowers facing resets," said Dale Vermillion, a mortgage industry consultant and consumer advocate.

With falling house prices, selling is difficult for Option ARM holders as they would net far less than they still owe their lender -- even supposing they can sell in a slow market.

As they owe far more than the house is worth and the market has been hit by a credit crunch, they also can't refinance. Bruce Rose's house in Boston, for instance, was valued at $325,000 in January 2006, but he owes more than $500,000.

"Falling house prices and negative amortization make the proverbial perfect storm," said Potomac Partners' Chappelle.

In the meantime, as borrowers continue to make their minimum monthly payments their mortgage increases in size. But the minimum payment also rises as a result.

"If people keep adding to the principal on their loan, eventually it becomes the bank's problem," First Houston Mortgage's Zugheri said.

For those borrowers who could never afford a conventional fixed-rate mortgage for their properties, most will probably end up losing their homes through foreclosure.

Others could afford their mortgages if a deal were struck with their lender for a fixed-rate mortgage with no spike in payments that comes with an Option ARM.

But that would leave investors who bought Option ARM-related bonds at a premium short on cash. Lenders One's Stern said that to avert a disaster with Option ARMs, U.S. Congress needs to broker a solution that "meets the needs of borrower, the needs of bond holders and preserves the sanctity of the housing market."

That may be too late for borrowers like Bruce Rose.

"Everything my lender told me was a lie," he said. "Surely that's illegal?"

(Reporting by Nick Carey; Editing by Eddie Evans)

Long conference call never a good sign.

Financial Services
MBIA Soothes Street In Marathon Call
By Mark DeCambre


MBIA (MBI) managed to allay concerns about the strength of its balance sheet in a lengthy conference call Thursday to discuss its shaky year-end results, but repairing its reputation may be an even tougher call. The Armonk, N.Y.-based bond insurer has been under intense pressure from rating agencies of late and has been the subject of a withering campaign by hedge fund manager Bill Ackman at Pershing Square Capital. The beleaguered financial guarantor rattled the markets by posting a net fourth-quarter loss of $2.3 billion, or $18.61 a share, compared with a net income of $181 million, or $1.32 a share during the same period last year. Shares initially responded by dropping sharply. But during a four-hour earnings call that stretched late into Thursday afternoon, CEO Gary Dunton and the rest of MBIA's management team attempted to lay bare the inner workings of an insurance firm -- whose business of insuring debt in municipal bonds and more hard-to-parse collateralized debt obligations has been oft viewed as esoteric and opaque -- appeared to reverse investor sentiment. Shares rebounded to close up 11% to $15.50. MBIA execs gamely culled through a list of more than 200 investor questions as it tried to reassure investors and analysts of its solvency and the sufficiency of capital it has raised to head off predicted losses in the debt it insures and appease finicky rating agencies. The company, which has received a cash infusion by private equity firm Warburg Pincus, underscored that it has sufficient funds to meet or exceed rating agency's capital concerns and voiced its belief that it is well positioned to go forward. "It is virtually impossible to imagine a circumstance in which MBIA would become insolvent," said CFO Charles Chaplin, answering one of a litany of questions submitted by Ackman just prior to the start of MBIA's marathon call. The guarantor made a point of answering all of Ackman's questions. The activist investor has very publicly questioned the legitimacy of the firm's accounting of its losses and in some cases its operations. Ackman has a significant short position in MBIA and its rival Ambac Financial (ABK) that could result in a billion-dollar bonanza for the manager should they fail. He has railed against MBIA for more than a decade. Dunton called many of those assailing his firm "fear mongers." "It is very difficult seeing the reputation of the company you love come under fire," Dunton commented. "We are scratching our heads because we have over $16 billion of claims-paying resources." What was not clear on the call, however, was what the future of the franchise might look like going forward as competition increases and further downgrades loom. Dunton quipped that there is a new tier system for monoline firms, which are in jeopardy of losing their high ratings, which they use to enhance the credit quality of municipal bonds and funky CDO paper. There are those that are in the "main house," the "doghouse" and "the outhouse," Dunton said referring to firms that have suffered reputational damage because they may lose their credit rating and those that have already seen their triple-A ratings notched down. "We believe that we are in the doghouse," Dunton said. "We're earning our way back." Getting back to the main house may be difficult if the rating agencies don't buy the financial guarantor's claims. Indeed, about an hour after the MBIA call wrapped up, Standard & Poor's placed MBIA on watch for a downgrade with negative implications and cut Financial Guaranty Insurance Co. to double-A from triple-A. Fitch Ratings made the identical move on FGIC Wednesday. Standard & Poor's did not, however, match Fitch's downgrade of Ambac from triple-A to double-A but has the firm on watch for a possible downgrade. Fitch has been viewed as aggressive in its ratings actions, but S&P and Moody's Investors Service, which has also threatened to downgrade MBIA, hold more weight since their ratings are typically the two that investors and buyers of rated securities abide by. Losing their triple-A ratings would mean Ambac and MBIA would be limited as to the sorts of business they can underwrite. But more to the point, a downgrade would limit the scope of their business, since the universe of deals for a double-A rated firm is smaller slice of the monoline insurance pie than that of a higher-rated firm. Adding to that dilemma is the likelihood that a host of firms including FGIC, Ambac and MBIA all could be jockeying for that much smaller slice. Competition from new entrants also will prove a problem. Billionaire investors Wilbur Ross and Warren Buffett are likely to serve as rivals to the insurers by creating new outlets to insure debt, as Federal Reserve cuts create an attractive environment to underwrite new business. Attracting new business is the challenge. Ross has toyed with the idea of investing in Ambac or buying the guarantor outright, according to media reports, but on Thursday he fell short of revealing his intentions, other than to predict that he expected a shakeout among the guarantors during a public event. The flap surrounding monolines has compelled New York Insurance Superintendent Eric Dinallo to try and orchestrate a bailout of the sector by encouraging investment banks to provide some support capital that could either bolster the insurers or be used to form a reinsurance pool to assume some of the liabilities on their books. An accord among some of the challenged banks, such as Merrill Lynch (MER) and Citigroup (C) might be difficult to achieve, especially since those banks have suffered their own massive writedowns on subprime-related bets.