Juan Toro

Last weeks were relatively quite in terms of economic news. Some good news from the retail sales front more a less worldwide (UK and the US specially), lower unemployment claims in the UK and few minor things. However markets still were relatively nervous. Monoline insurers had an important role in this nervous state. Monoline insurers were anew word for many, a hidden economic agent that hardly appeared in the news. But it is playing quite a big role in the last weeks. Are they going to be downgraded by rating agencies? Are regulators promoting changing legislation so they can operate within new market conditions? Is Warren Buffet going to rescue some of them?

Before all these questions are answered we have to ask ourselves why they matter so much. What is the economic effect of these downgrades? Briefly put, there are a few reasons why they are important economic agents whose downgrade can induce a chain reaction that affect the balance sheet of many companies. These are some consequences of the downgrade just to name a few:

a) If a monoline gets downgraded, bonds they have enhanced are downgraded as well.
If an investor has a mandate to hold investment grade assets, they have
30 - 45 days to sell the assets that have been downgraded.

b) CDO tranches kept by banks in their balance sheets are top quality that do not count
against their capital. Any downgrade of the CDO enhancer leads to a revision of the capital needs by these banks.

The monoline insurer’s downgrade imply a downgrade of everything insured by them and hence a immediate revision of the risk class of many assets. This is why such an unknown has become so important.

Posted on 14 Febrero 2008 in Financial Markets

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