Bond Issues, Monoline Insurers and the Fallout from the US Subprime Mortgage Crisis

With the current crisis in the US subprime-mortgage market, observers are keen to speculate on who will be most affected by the fallout. Many onlookers are claiming that one of the industries that will suffer most adversely will be the so-called monoline insurers. These insurers guarantee efficiency in repayment of bond principal and interest when defaults occur. Monolines are highly geared in comparison with conventional insurers therefore leaving them more exposed in an unstable environment. Despite this, Monolines stress test each and every potential transaction under hugely stressful situations and accept only those transactions displaying no losses. This is one of their more conservative protection measures and they do this to cover themselves in the case of things turning bad.

It has been claimed already this year that MBIA, one of the largest monoline insurers in the US, has suffered losses and that it has made large payments in order to quell allegations of instability. One of the major factors considered by observers is that MBIA’s huge leverage. Outstanding guarantees currently stand at 150 times capital.

In the face of this however, monolines held strong during recent market crises such as the downfall of New Century mortgage lenders. Subprimes only account for approximately 1-3% of direct exposure. It is difficult to envisage a situation where the market would suffer a loss of twenty times what was experienced last year, as this is what it would take to eliminate the capital held by these insurers. It is clear that demand will decrease for these types of products given the current market climate. However, most monolines are remaining positive, voicing hopes that market ructions may actually increase the demand for structured products, as investors seek comfort in the guarantees they offer.

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