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Friday, February 08, 2008

Monolines: How much Capital is Needed?

by Calculated Risk on 2/08/2008 04:19:00 PM

A few weeks ago, I mentioned Sean Egans (of Egan-Jones) estimate that the monoline insurers need $200 billion in capital.

To balance Egans' view, here is a response from Thomas Brown at Sean Egan: Giving the Backs of Envelopes a Bad Name

I got a call last week from Sean Egan of bond rater Egan Jones after I expressed doubt here about his much-bandied-about estimate ...

... Egan told me that he looked at each guarantor’s subprime mortgage and second lien exposure, and simply assumed 30% loss across the board. He then added up his estimates for all the guarantors, and arrived at $80 billion. Then he multiplied that by three, on the assumption that the rating agencies require three times anticipated losses to maintain a AAA rating. Then he took the result, $240 billion, and rounded it down to “over $200 billion” because it was such a big number.

I kid you not. Sean Egan has done the impossible. He’s managed to make S&P and Moody’s look like models of analytical rigor by comparison.
If accurate, I'm very surprised Egans' analysis wasn't more rigorous.

Here is another bearish view from David Roche writing in the Financial Times: Insight: The fire threatens credit insurance
If the monoline guarantees on bonds and credit derivatives were to be removed, the rule of thumb is that every 1 per cent decline in the price of insured bonds would give rise to $10bn of losses on bond portfolios elsewhere in the system. We estimate bond portfolio losses of $150bn-200bn were this to happen – or equivalent to the impact of the subprime crisis on the US banks.
I'm not confident that anyone has a concrete estimate of the future losses. Part of the problem is the insurers only pay for actual realized losses, and it takes a long time for those losses to show up (even though we all know they are coming). This is a story that will unfold slowly, and the ultimate losses depend on how far house prices fall, and on how many homeowners default.