The CDO Downdraft

Yesterday the “Muni Bond Dilemma” was discussed; today the other shoe fell. A good number of Muni Bonds are insured by MBIA. Today Fitch downgraded all the bonds insured by MBIA (172,860 municipal, 162 non-muni) to Rating Watch Negative due to its CDO exposure

In a shocking revelation the world’s largest bond insurer, MBIA, disclosed that it guaranteed $8.1 billion of collateralized debt obligations that have significant probability of losses. The analyst community was disturbed that this information has been withheld until now. Especially in view that MBIA may not have adequate capital to cover widespread losses. Other insurers are also being given a critical re-evaluation by rating agencies. Several are stumbling and one in particular, ACA Capital Holdings (ACAH.PK), is on verge of bankruptcy unless a rescue occurs.

MBIA fell 26% to $19.95 today in reaction to the news. A more severe response was given by Fitch with the downgrade of all the Muni-debt backed by MBIA. The instability caused by the CDO exposure of the insurer effectively is hitting the entire Muni Bond market.

There is an increasing probability that one or more of the bond insurers will quickly dive into bankruptcy. The majority of Muni-Bonds enjoy high ratings due to the insurance backing. Failure, due to unrelated CDO guarantees, of the insurance firms that also back the municipal bonds is likely to cause many these government issued bonds to be cut from high ratings to near junk.

Fitch Places 173,022 MBIA-Insured Issues on Rating Watch Negative
http://www.businesswire.com/portal/site/home/index.jsp?epi-content=GENERIC&newsId=20071220006121&ndmHsc=v2*A1198155600000*B1198219069000*DgroupByDate*J1*N1000837&newsLang=en&beanID=202776713&viewID=news_view

MBIA Tumbles on $8.1 Billion of CDOs, Fitch Warning
http://www.bloomberg.com/apps/news?pid=20601087&sid=aF5n2mMwD_VE&refer=home

Ambac, MBIA and rivals may lose AAA ratings: S&P
FGIC's rating also imperiled; ACA Capital ratings slashed to CCC
http://www.marketwatch.com/news/story/sp-warns-may-cut-aaa/story.aspx?guid=%7B13D7F179%2D88E0%2D4995%2DA566%2DB41CC5BBEC5D%7D&siteid=yhoof