A funny thing is going on in the financial markets. Monoline insurer Ambac (ABK) is slowly but steadily moving towards a stock price of $0. It collapsed about 40% today when it issued its earnings and they were worse than expected. Ambac's business is to re-insure bonds issued by Wall Street. Ambac blesses the bonds with its credit rating, a AAA, the highest possible, and magically those bonds trade at higher levels because of Ambac's guarantee. Ambac is essentially transferring its credit rating to these bonds and is extracting a fee for the service. It is selling insurance.
So what's the big deal? The big deal is that Ambac is really only functional as long as its a AAA credit. But the stock is going to $0 you say. How can it be a AAA credit and have a stock worth nothing? One of my favorite financial writers, Bill Fleckenstein raised this question today.
I'm not really sure how this is possible but one thing is sure, the ratings agencies like S&P and Moody's are moving really slowly on this. There are obviously serious troubles here, why aren't they downgrading Ambac? Well, if they downgrade Ambac to a worse credit rating, all these bonds that are AAA rated by virtue of Ambac's guarantee will lose their AAA rating. Those bonds are held by large institutions that are sometimes chartered to only hold AAA rated bonds. Those institutions would have to sell those bonds, creating a liquidity crisis and hurting the bond and stock market. This could become a real mess.
There is something fishy going on here but something tells me it won't take long to see what happens.