February 6, 2008 11:56AM

Buzzsaw Ben to the Rescue Again?

By Elizabeth MacDonald

Why do I feel like everyone has lost their minds?

The markets are hollering for even deepr cuts to the Fed funds rate. Futures markets are betting on a half-point cut in interest rates, from 3%. Traders put the chance of a three-quarter-point cut at 28%.

I’ve said it before–rate cuts can’t make all bad loans good again. Real rates are already near zero (after inflation). Rate cuts do debase the dollar, which is why inflation is rearing its ugly head.

This is the worst time to be the top U.S. central banker. Bernanke needs crocodile-thick skin now, because he’s damned if he does, damned if he doesn’t.

I’m usually very mild-mannered. Today is Ash Wednesday, the first day of the Catholic Lenten season of penance. I am wondering if, because of my peevishness, my Catholic priest will put an even bigger ash mark on my forehead for saying all this (I actually think some priests use Catholic foreheads as billboards to advertise the faith with big honking ash crosses, but hey that’s me.)

(And another thing, I also expect my Fox Business buddies here, Ray Hennessey, Charles Brady, Connell McShane and Robert Gray, even though Gray is not Catholic, will get extra big ash mark crosses, bigger than the one Jesus carried up to Calvary, because of the penance they owe for tormenting me with hot pitchforks on a daily basis. That goes for you too Kevin Magee–oops he runs the network, I take that back, I actually torture him. No actually it’s his beautiful and lovely assistant Valerie Alexander who torments him. And no big ash cross billboards on the foreheads for Neil Cavuto, David Asman or Liz Claman, they are nice to me, ok I’ll stop now).

Anyway, I wasn’t always like this, so peevish.

Ok, since this is a blog I’ve been instructed that I am supposed to talk about myself and let you know who I am. Which I loathe doing, talking about myself. I, thankfully, grew up with seven brothers and sisters who I love and adore who don’t like treacly sentimentality. Puts them in a diabetic coma.

More so, they get serious allergic skin reactions to anyone who takes themselves seriously. So bear with me. I didn’t talk until I was five. My mother thought I was deaf. I had a really bad speech impediment. I was painfully, agonizingly shy. I used to hide behind furniture and in drapes.

I say all this because I feel bad that I want to now wring someone’s neck. I like to think I’m a nice shy geeky girl. Neil Cavuto recently asked me if I was kind of geeky growing up. I said yes and that in high school I was also a virgin by popular demand.

Anyway, back to my peevishness. Grim economic data has the stock market wondering if Buzzsaw Ben will take a chop once again out of the federal funds rate, a rate that’s now at a low 3%. Another rate cut that would come amidst a fiscal free-for-all, a $146bn election year handout (of taxpayer $$) from the government.

The fed funds futures markets is now betting Buzzsaw Ben will take another big whack out of rates, at a time when real rates (after inflation) are already around zero. Cutting so dramatically is quite unlike his predecessor, “quarter-point Al” Greenspan, known for moving in slow 25 basis point increments.

The market’s thinking goes that Bernanke will ride to the market’s rescue once again, thanks to weak gross domestic product numbers and iffy jobs data, coming amidst a mixed bag of so-so economic data, (mortgage applications up, productivity numbers not so bad).

It’s clear though that Buzzsaw Ben is worried. He has been trying to apply the paddles to the Goldilocks economy with an influx of liquidity through the discount window as well as dramatic cuts in rates, a total 125 basis point cut in the span of 8 days. Those cuts came on top of the total 100 basis points in cuts since September, when it was at 5.25%.

But this is why I’m cranky. I’ve said it before and I’ll say it again—Buzzsaw Ben can try all he wants, but a rate cut can’t turn all sick mortgages into healthy loans. It certainly helps keep afloat overly debt-addled consumers, absolutely, but all loans?

No way, not when many loans were downright fraudulent, given to borrowers with no assets and zero income. It’s no small irony that borrowers who lied about their incomes on their applications to get fat mortgages can now be honest about the real dire straits they are in to try to get their loans frozen at the low teaser rates offered under the government’s mortgage bail out plan.

As for another Fed rate cut, the Fed can only control the price of credit—it can’t force the banks to make credit available with whacks at the fed funds rate, not when they remain nervously suspicious about everyone else’s balance sheets. And with the dollar getting so debased, watch when inflation comes a cropper.

And this is why I’m really cranky. The market’s problems are structural. For one, there is no standard way on Wall Street to value subprime securities, called collateralized debt obligations or CDOs. Every investment house has its own way of valuing them, which essentially amounts to holding up a wet finger in the wind. There needs to be some kind of computer valuation system for subprime securities, modeled after the corporate bond computer valuation system called Trace. If they can cook up this mess, (heck if we can put a man on the moon), then Wall Street geniuses can surely create some kind of computer valuation network for subprime securities.

And yes we know now that the credit rating agencies who got paid millions of dollars in fees by Wall Street to rubberstamp hundreds of billions of dollars worth of subprime securities with triple A ratings have been dismally slow off the mark in downgrading these damaged offerings. They were slow off the mark in prior crises as well. Now Standard & Poor’s says the housing crisis could produce corporate losses that may top $265 billion. Expect the steam pipes to burst even more at the banks.

And Moody’s now expects investors to believe that its latest grand idea, to replace its old ratings system, which used letter grades, with a new one based on a number system, will fix the mess? That its new plan to put “warning labels” on securities like CDOs because they are complex and hard to rate will stop future crises? That’s it? That’s like getting the U.S. Surgeon General to put a Surgeon General warning label on crack.

The market’s problems lie with the bond insurers. A quick primer: bond insurers like MBIA, Ambac Financial Group, Financial Guaranty Insurance and Financial Security Assurance guarantee yield payments on more than $2 trillion of securities. Those guarantees let states and cities borrow money more cheaply so they can, in turn, build bridges and tunnels more cheaply, which lessens local taxes.

The bond insurers’ downfall, though, began when they plowed into insuring securities built on subprime loans, generally called CDOs, in 1998.

And think about this—Wall Street paid bond insurers tens of millions of dollars in fees to insure the yields on thousands of toxic securities built on fake loans that borrowers should not have gotten in the first place. Wall Street essentially paid the bond insurers to confer their triple A rating on thousands of subprime securities worth hundreds of millions of dollars. Only about 16 companies have triple A ratings (IBM doesn’t).

So the bond insurers and the credit ratings agencies went along with the sharks on Wall Street, executives who could sell fertilizer to the guy who cleans up after the elephants in the circus.

Over the past few weeks, Fitch Ratings have stripped bond insurers Ambac Financial and Financial Guaranty Insurance of their triple-A ratings. They are now double-A rated entities. Standard & Poor’s and Moody’s Investors Service may soon make similar moves. Ambac is on life support. Moody’s also threatens to downgrade MBIA.

That’s really bad. The bond insurers’ whole business hangs on persuading bond investors that its guarantees make bonds gilt-edged.

But wait, the bond insurers like MBIA say. They will tell you it has got adequate capital reserves of $8bn to support its $625bn book of business. But look closer at those capital reserves and you may start hyperventilating in panic: Only a fraction is actual cash. Much of it is in the form of credit lines, as well as premiums that it has collected but not yet earned, in other words, payments for covering bonds in future years, plus hundreds of millions in premiums that have yet to come in the door. That’s right, unearned premiums.

And MBIA has been notorious about keeping investors in the dark. Recently, in the dead of night, well after midnight, MBIA announced it had swung to a fourth-quarter loss of $2.3bn, or $18.61 per share, after a $3.5bn writedown. The pundits were right, MBIA took a torpedo in the boiler room, but it tried to bury that bad news which is par for the course. It routinely submarines the bad news in its filings hoping investors won’t find it. For instance, investors had to go digging to find out that MBIA is exposed to $8bn in CDO squared investments, CDOs that are made up of other CDOs. Ad infinitum. Talk about being through the looking glass.

And now comes this after-the-fact refereeing. To shore up their damaged reputations, the credit rating agencies are scrambling. Late in the game, in the last few months of 2007, the ratings agencies started whacking the ratings of hundreds of billions of dollars worth of these subprime securities.

That’s what is rocking the market. Because when you downgrade those securities, banks have to hoard even more cash, beyond the sums they’re scrounging for now to cover their massive writedowns on bad mortgages and consumer loans. They need that cash to provide a backstop against those now downgraded bad assets.

Worse, when the bond insurers themselves get downgraded, all of the securities they back get downgraded in unison. Which hurts the banks once again, who have to shore up even more cash in the face of that potential event. Even more bank writedowns just from an overall downgrade of the bond insurers range from $40bn to $70bn. When the bond insurers’ claims paying ability drops even a notch below AAA, the bond insurers’ coverage is worth a heck of a lot less because they’d have no Triple A rating to sell. It becomes just a paper promise–perhaps as it was ever thus.

That’s why the financials, as one pundit put it, are trading like they are in intensive care.

There’s talk of a $15bn bailout by the banks of the bond insurers orchestrated by New York insurance watch dog Eric Dinallo. Why the banks would put money into the bond insurers, only to see them lose their triple A ratings later on, creating more writedowns for the banks has some analysts scratching their heads.

There’s also talk of the bond insurers going hat in hand to bankruptcy wizard Wilbur Ross and legendary investor Warren Buffett.

Our own Liz Claman delivered this scoop, that Buffett again has said no dice, not interested in bailing out the troubled Ambac and MBIA. Buffett’s newly created bond-insurance company, Berkshire Hathaway Assurance, is already up and running in New York State and has done “a couple” of deals.

So, when a value genius like Buffett says no, that means he sees no value in those businesses. And again, Ross is a bankruptcy pro, expert at picking off distressed assets. Get the picture?

It’s Ash Wednesday, our Connell McShane reminds us. “Remember man that you are dust, and unto dust your stock portfolio shall return,” McShane gravely intones. At least someone has a sense of humor in this gloom.