"The moral crusader and ambitious politician has fallen from his lofty pedestal and a lot of people hope it hurts" - Helen Yates, Editor - Global Reinsurance.
The thinly-disguised schadenfreude at Eliot Spitzer's downfall – particularly in the broking quarters of the industry – is unsurprising. The moral crusader and ambitious politician has fallen from grace. And a lot of people hope it hurts on the way down.
Spitzer carved a career out of taking some of New York's most powerful companies to task and in the process made more enemies than friends. Had the opposite been true his mistakes might have been more readily forgiven. As it is, Spitzer will surely go down in history as one of the bigger hypocrites in US politics. There is a lesson in there for us all. As the old adage goes, you reap what you sow.
More the shame that Spitzer was actually talking a lot of sense before the world found out that he was the client of a high-end prostitution ring. Predicting the impossible situation facing the bond insurance sector, he had apparently been working hard behind the scenes to prevent further rating downgrades.
Addressing US Congress in February, Spitzer pleaded with regulators to do something about the crisis facing the monolines. "If we do not take effective action, this could be a financial tsunami that causes substantial damage throughout our economy," he warned. Now the "Sheriff of Wall Street" has inadvertently added to the banking sector's woes at a time when it is at its most vulnerable. Spitzer's resignation could just prove to be the straw that broke the camel's back.
Spitzer and New York insurance superintendent Eric Dinallo feared that downgrades could lead to banks having to offload sub-investment grade securities. In an effort to bail out the insurers – which collectively insure over $2.4trn of debt – Dinallo pleaded with a number of top banks, urging them to lend the troubled bond insurers much-needed capital. The aim was a combination of capital raising and restructuring along "good bank/bad bank" lines. Some of this has taken place, with Spitzer apparently playing a key role in helping Ambac secure $1.5bn in early March.
Still, this doesn’t change the fact that Spitzer's successor, governor David Paterson, has a major job on his hands – and he knows it. "It is now time for Albany [New York State capital] to get back to work as the people of this state expect from us," he urged shortly after Spitzer's resignation.
Berkshire Hathaway's controversial deal to reinsure $800bn of the municipal bonds guaranteed by Ambac, MBIA and Financial Guaranty Insurance is now off the table. The deal was rejected outright by Ambac. "We tossed our hat into the ring and they tossed it right back," said Berkshire boss Warren Buffett speaking in an interview on CNBC.
Not that it was any wonder that the deal was turned down. Buffett is the world's richest man for good reason. He had offered to take on the bond insurers' best quality business for a steep premium; leaving the insurers to deal with the "crap" nobody wanted, as one source put it.
The downgrades that Spitzer worked hard to avoid are now inevitable. Security Capital Assurance and Financial Guarantee Insurance Company have lost their "A" ratings. Fitch downgraded SCA to "BB" and its subsidiaries saying it no longer had the necessary capital to maintain an investment grade rating.
It came at the end of a tough week. SCA's decision to terminate seven credit default swaps (CDS) with Merrill Lynch has led to the bank suing SCA?subsidiary XLCA. XLCA claims Merrill itself terminated the CDS contracts by offering voting rights to the collateral to another bond insurer. Remember CDSs? They led to AIG's $11bn writedown and Swiss Re's $1bn writedown – and the Swiss reinsurer had only entered into two transactions.
Experts are predicting that other monolines will attempt to reduce their exposures to CDSs in a similar manner, using voting rights as a way out. As yet, there are no precedents for lawsuits involving bond insurers – but it could all wind up getting very expensive.