RGE: Time To Downgrade the Monoliners

The forest issues is simple: a business – the monoliners’ insurance of securities and holding of risky ABS securities – that is fundamentally based on having a AAA rating is a business that does not deserve a AAA rating in the first place: it is clear to all that if a monoliner were to lose its AAA rating the essence of its business model would fail and such monoliner would have to close shop. But in any industry you have firms that can do business and thrive with an AA or A or even lower rating, even among major financial institutions. Here we have instead an industry that would go bankrupt as soon as its AAA rating is lost: by definition this is not an industry that can deserve a AAA rating. So the issue is not one of how sound these monoliners are managed or whether they have enough capital or whether they can raise new capital to maintain their AAA status. There is a fundamental and conceptual flaw in a business model that is conditional on a AAA rating and that is in a business that insures assets and firms that do not have a AAA rating. This is analogue to the voodoo finance of taking subprime and BBB mortgage backed securities and turning them into AAA by the black magic of CDO tranching.
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Roubini brings up an interesting point.

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