The Great Bond Game

Recently two large bond reinsurance companies, Ambac and FGIC, have entered into discussions with regulators to determine if these companies can split themselves asunder. The goal is to create one company that has a portfolio of municipal and highly rated bonds while the other company is saddled with junk. Its a cry for aid.
A plausible assumption is that the executives at these companies are betting that the government will allow them to float a new company that has a dream portfolio of AAA bonds. The only way to make that work is if the government comes in and saves the financial sector by handing out cash for the defaulting junk bonds. But let's backup and ask how this happened.
2001. You know what happened. The FED responded by dropping rates to the floor. This pushed money out of the bond market, as cash could get better returns on other investments. The stock market was fizzling after the dotcom bubble, so people began putting money in their houses. Analysts and financial advisors agreed that is was a viable investment, as house prices had gone up 50% over the 1990s. Furthermore, the federal home mortgage deduction encouraged people to finance their houses to the hilt, so purchasing a larger and more expensive home could lower one's income tax burden. So investing in houses was good, right?
To a point. But the US over-invested. By a substantial marginal and in the wrong type of house. But the point that matters here is that anyone who wanted a house was given one. Anyone. Now you might be "eqalitarian" and think that everyone is entitled to everything that anyone else has, but I'm not. Houses should go to those that can afford them. By giving away houses, both the prices of houses and the chances of default were pushed up. That is not a virtuous circle and soon the bond market began to exhaust itself. Fancy debt vehicles called Collateralized Debt Obligations were created so that many of these "subprime" mortgages could be packed together. Then the mortgages were graded based on a fictitious reasoning that some lots were AAA and some were junk. These were resold to the bond reinsurers, Ambac, MBIA, FGIC, etc. The critical point here is that these companies allowed themselves to be sold junk bonds that were rated AAA. When these bonds began defaulting, which AAA bonds aren't supposed to do, the subprime housing bond market began to deflate. Then housing hit a rough patch, as inventories of unsold houses began to pile up, and suddenly big corporations like Citi and Morgan Stanley began writing off large sums for their subprime exposures. Now several forces are converging on housing as the market corrects.
As for FGIC and Ambac being split into separate companies, let's hope so. I don't get government aid for many things, so it would be nice to get some, as the markets are sure to benefit from a handout like that.

Boring political stuff

Mitt Romney stepped down yesterday, as he thinks that continuing to fight John McCain would damage the party. Wow. What a team player. Its party discipline like Mitt's that allows the Republican party a persistence in power politics that's disproportionate to their base's size. If only the Democrats could do something like that. But their choice isn't clear. Mr. McCain's shot at the nomination was secure by his substantial margin. The democratic contends have a much murkier decision because they're so close. Their closeness, combined with the elongated election season, will lead to a prolonged political battle that saps the power of the Democratic Party for the national election.
Hillary and Obama have a different destiny than the Republican contenders. Their historic run will be marred by the fact that they were run against each other. Don't think that I'm begrudging them their right to run for president. I think a monkey's uncle should be able to run for president. I even think people should be allowed to vote for who they think is proper. What I am saying is that the democrats will flail at each other in an increasingly acrimonious way that will deplete their reserves and leave them wide open for John McCain to rip them apart.
Lets examine McCain versus Hillary first. Hillary is low on funds but up on delegates, so there's no point in quitting now. I remember John Kerry being low on funds during the primaries, taking out a personal loan against Theresa Heinz's fortune, and going on to lose the national election in a "just barely" sort of fashion. I don't think that will happen with Hillary. She'll spend most of her money on beating obama and that whole time, McCain will be stocking up cash and moderating his position so that he can win. Its called the Median Voter Theory. The end result of that strategy is Hillary getting thumped on by a war hero.
Now ponder what Mr. Obama will do. He's raising money like a champ, but is still behind in the delegate category. However an ephemeral thing called "political momentum" is propelling him along to an extent where he'd be a fool to quit. Great. Now he's going to slug it out with Hillary through every state in the Union. Its actually quit democratic, but the whole reason we have shortcuts in our democratic system is because the system takes too long and is too expensive. Obama will do ok against Mr. McCain, but the debates will hurt him badly. McCain will look presidential and on the ball, while Obama's strength lies in laying out the bullshit for crowds. Being parsed by a seasoned political fight like John McCain will be damaging. Middle aged white america will flee Obama and the republicans win.