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.