Why banks can’t afford to save the bond insurers

After another grim day, rumours of a bail-out for bond insurers gave the Dow Jones a late boost yesterday. But before investors get too excited, they should consider one thing: where's the money going to come from?

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Arty types often like to sneer at those involved in the financial sector, dismissing them as dull grey suits'.

But recent events have shown that, when they put their minds to it, the suits' can be far more creative than the media studies students of this world.

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Just look at all the creative financing that's been going on. "I know, let's take 100 junk-rated subprime mortgages, bake them into a cake, keep the worst bits for ourselves, then chop the rest into 80 AAA-rated slices and sell them!" That idea took some imagination.

Then there's the government's bail-out of Northern Rock. "Let's pay taxpayers back the £24bn Northern Rock owes us, by issuing £24bn of taxpayer-guaranteed bonds secured against Northern Rock's mortgage book! Just as we're going into the biggest housing downturn Britain has seen in 20 years!" What sick mind came up with that?

And now the would-be Jackson Pollocks on Wall Street are trying to come up with another bail-out for the bond insurers. We suspect the end result will be just as messy

After another grim day on the markets, rumblings that another bail-out is being organised sent the Dow Jones soaring in the last minutes of trading.

Here comes the cavalry - again

This time the cavalry charge is aimed at saving the bond insurers. We've written about the bond insurers a few times already, but just to recap, they're the ones who basically underwrote all the dodgy debt that's been sold out there. Not only that, but they also underwrote a fair chunk of the insurance that was meant to pay out if said dodgy debt defaulted.

Now that bad debts are soaring, the insurers have found that they don't have enough money to make good on their commitments. That could mean banks having to write off all the insurance they took out against debts going bad. It could also mean a mass fire-sale of bonds, as these would lose their investment-grade credit ratings if the insurers backing them went bust or were downgraded.

So now, according to The Telegraph, the hope is that New York Insurance Superintendent Eric Dinallo can convince the banks (who of course stand to lose a lot if the insurers fail), to stump up $5bn in capital right away, with another $10bn to follow. This could prop up the insurers for now and help them to get back on their feet.

That's the plan. Sounds good. Just one problem where are the banks going to get the money from? Several of them have already had to get cash injections from sovereign wealth funds to prop up their own capital bases. So they're not exactly flush with money to bail out anyone else.

The Telegraph suggests that "if the banks are not interested, Mr Dinallo could turn to the private equity industry and other investors". But realistically, if these other' investors were interested, they could already have snapped up the insurers for buttons most have seen their share prices fall by 90% or so in recent months. Warren Buffett certainly wasn't interested he recently set up his own bond insurer rather than buy into any of the existing ones.

I suspect this particular bail-out will fall flat on its face. Whether the US government will then step into the breach and find some way to stealth-nationalise the bond insurers, just as the British government has effectively nationalised Northern Rock, remains to be seen.

Soros has the UK in his sights

And now to Davos. I'm not sure what Davos is for. The newspapers seem to like it, but as far as I can work out, it's just another over-hyped ego-fest for the great and the good. Chief executives and top economists get to dish out dull quotes on obvious subjects, while mingling with supermodels and actors who try to demonstrate their intellectual credentials by appearing fully-clothed and not smiling in photographs.

But one person said something worth hearing yesterday George Soros. Mr Soros, as I'm sure you're aware, is the man who in 1992 broke the Bank of England, and thus wiped out the Tory party's reputation for economic competence. He made about $1bn betting that sterling would fall as the Government tried and failed to hold onto its place in the European Exchange Rate Mechanism.

Well, the bad news for Britain is that he may well be betting against us again. Mr Soros believes the UK is headed for recession, which puts him out of step with a lot of economists, though we couldn't agree with him more. He also points out that the USA's problems are down to far more than just a housing crisis.

"The current crisis is not only the bust that follows the housing boom, it's basically the end of a 60-year period of continued credit expansion based on the dollar as the reserve currency. Now the rest of the world is increasingly unwilling to accumulate dollars."

But then, that's what happens when you rely on cheap money to bail you out of every problem. The US could get away with it for longer, because it was the biggest economy on the planet. But that era may finally be coming to a close.

City expert Simon Nixon has written an excellent column for this week's issue of MoneyWeek (out on Friday), spelling out exactly why the constant bail-outs in the financial sector are destroying capitalism and robbing taxpayers. I urge you to read it and if you're not already a subscriber, you can get your first three issue free by clicking here: 3-week free trial

Turning to the wider markets

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Oil majors lead FTSE falls

London's FTSE 100 index suffered another day of sharp falls yesterday, ending the day down 130 points at 5,609. The broader indices were also lower. Oil majors and mining stocks bore the brunt of the day's losses as the price of crude oil fell steeply, as did metals prices. For a full market report, see: London market close

Elsewhere in Europe, the Paris CAC-40 slumped 205 points to end the day at 4,636 as Wall Street opened weaker, with oil giant Total down nearly 6%. Over in Frankfurt, the DaX-30 was 3330 points lower, at 6,439.

Despite a dismal start, US stocks broke their six-day losing streak yesterday, with financials leading the way on hopes of another Federal Reserve rate cut next week. The Dow Jones recovered from an earlier 325-point drop to end the session at 12,270, a 299-point gain. The tech-heavy Nasdaq was 24 points higher, at 2,316. And the broader S&P 500 was up 28 points, at 1,338.

In Asia, the Japanese Nikkei was up 263 points, at 13,092, whilst the Hang Seng was down 550 points, at 23,529.

ICAP profits boosted by market volatility

Havng fallen over $2 to $86.99 a barrel in New York late yesterday, crude oil futures had climbed back to $87.77 this morning. Brent spot was at $87.79 in London.

Spot gold was also firmer this morning, last trading at $892.20 - up from $884.70 in New York last night.

Turning to forex, the pound was last trading at 1.9543 against the dollar and 1.3363 against the euro. And the dollar was at 0.6836 against the euro and 106.1 against the Japanese yen.

And in London this morning, ICAP revealed that it had been a rare beneficiary of recent market turmoil. The company, which brokers transactions between banks, predicted expectation-beating full-year profits of over £307m thanks to higher trading volumes. ICAP shares had risen by as much as 6% in early trade.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.