Ambac Smacked With Downgrade

MBIA, in a statement Friday morning, said it was "surprised" at Moody's action, given the rating agency last month said MBIA had "reestablished a robust capital position" and expected to revise its outlook to stable. Fitch on Wednesday had removed MBIA from its rating watch negative list and changed its outlook to stable.

"We have developed and are implementing a comprehensive capital strengthening plan in good faith reliance on Moody's stated requirements," MBIA Chairman and CEO Gary Dunton said in a statement Friday, citing a plan that would inject as much as a $1 billion into MBIA. "We believe our capital plan meets or exceeds the requirements previously outlined by Moody's and the other two major rating agencies."

The question that stands out now is will other rating agencies now follow suit and downgrade Ambac -- and take a harder line on the other monolines. A call to Standard & Poor's and Moody's was not immediately returned.

So far, the only monoline to see its ratings chopped down have been ACA Capital -- a New York-based debt insurer that for its short time in the business has managed to underwrite some of the riskiest paper on Wall Street. Ratings on that firm were downgraded by S&P from single-A to junk status triple-C. ACA, as outlined in a Wall Street Journal article Friday, is in a mad dash to secure grants of forbearance from its creditors and insureds so that it can conduct an orderly unwind of its portfolio.

The downgrades forced Merrill Lynch, which on Thursday reported a woeful fourth-quarter loss of $9.83 billion along with billions in debt writedowns, said that it had to take additional writedowns due to the ACA downgrade.

Merrill's roughly $3 billion writedown tied to ACA is big number, but pales in comparison to outsized amount that it has endured on bad mortgage paper. If the much larger firms such as MBIA and Ambac suffer a similar fate, however, the entire market could buckle.

Josh Rosner, managing director at research firm Graham Fisher in New York told TheStreet.com the monoline problems could be a jagged pill to swallow for some of the major firms, because they act as counterparties, providing additional protection for investors in the form of derivative securities known as credit default swaps.

In this shaky economic environment it has been easy to take the bearish gloom-and-doom posture, but the implications could make the subprime collapse look minor by comparison.

Is it likely that these firm's could go bankrupt? Let's hope not, but there are investors including Pershing Square's Bill Ackman that are not only predicting a monoline collapse but also betting on just that. Ackman stands to generate billions in fat profits if Ambac and MBIA go under.

The rest of the market, including bigger mortgage firms such as Fannie Mae (FNM) and Freddie Mac (FRE), who also use bond insurers, however, may be facing quite a bit of disarray.

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