More Bad News For Bond Markets
Earlier this morning Ambac Financial Group Inc., the world’s second largest bond insurer, posted a $1.66 billion loss for the first quarter as well as operating losses that were over three times worse than what many analysts expected. This will have a negative impact on the over $500 billion worth of bonds that Ambac insures.
Credit default swap spreads surged for the embattled bond insurer as traders increased bets that Ambac won’t be able to meet it’s bond guarantees. It also casts serious doubts as to whether the worst of the credit crisis has finally passed, which many financial experts were claiming.
While Ambac survived it’s last threat of a ratings downgrade of it’s financial strength by raising $1 billion in cash in a sale of stock, it will grow increasingly difficult for the company to raise additional capital. Ambac is currently seeking shareholder approval to nearly double it’s shares of outstanding stock to 650 million shares up from 350 million.
A ratings downgrade would have serious repercussions in the entire bond market. Certain institutional investors like government pension funds are required by law to hold only AAA rated securities and would be forced to sell any Ambac insured bonds at a loss.
The flood of these bonds on the market would further drive up yields as prices fell. Financial institutions that continue to hold these bonds would also have to revalue their portfolios and realize these investment losses on their books.
It will also increase calls for a government bailout of the bond insurance industry, like the Fed did with Bear Stearns. However, this would do little to alleviate the underlying problems in the financial sector and would only serve to shift the risk of loss from investors to taxpayers.
