I've spent a lot of
time talking about what I consider Bank of America's
risky gamesmanship in its multi-pronged litigation with the bond insurer
MBIA, but it may be that I've underestimated that risk by focusing on the
downside for the bank in MBIA's breach of contract and fraud suit. Under a
not-implausible scenario, BofA faces serious risk in its regulatory challenge
to MBIA's transformation that's going to trial on May 14. And ironically, the
risk comes not from losing the case -- but from winning it.
According to a
sophisticated and well-advised MBIA institutional investor that has devoted serious
resources to analyzing the issue -- trust me, even though the investor doesn't
want to broadcast its involvement, this is a seriously savvy player -- if Bank
of America and two French banks succeed in overturning MBIA's 2009 split into
separate muni bond and structured finance businesses, there's a reasonable
likelihood that BofA could wind up at the back of the line of MBIA claimants,
waiting years for whatever scraps are left over from payouts to municipal bond
insurance policyholders.
Here's why. For all
sorts of reasons, bond insurers can't write policies directly backing credit
default swaps, which often function as bets by one investor on the other
party's failure. Instead, in the economic boom years, monoline parent companies
would create special purpose vehicles to engage in credit default swap deals.
The insurer would then write an insurance policy backing the special purpose
vehicle. The monoline essentially issued insurance on a product it technically
couldn't insure; the CDS counterparty would end up with a hedge on its CDS
risk. It's widely believed that Bank of America is the counterparty in more
than $1 billion of MBIA-backed credit default swaps. Indeed, it's part of the
bank group suing MBIA over its restructuring because (according to many
statements over the years by the banks) BofA and its allies are concerned that
MBIA's structured finance spinoff doesn't have the money to pay what it owes
policyholders, including whatever it owes through these CDS deals.
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