MBIA Sues Merrill Lynch


Now this is an interesting lawsuit. So MBIA is suing Merrill for “flipping” its losing positions in CDOs. MBIA was in the business of insuring, or “wraping” Investment Grade, mostly the most senior piece, CDO tranches. MBIA is accusing Merrill for not performing a cost-effective and detailed analysis of the CDOs and the mortgage loans underlying them. MBIA says they mostly relied on the rating agencies models.

Now I’m not trying to let ML off the hook here, and I have a feeling that they were doing a bit of offloading, and of course the rating agencies were all to happy to play the “game” which was basically paying for a huge part of their revenue growth in ’05, ’06 and ’07. However, it sounds a bit as if MBIA is trying to pass the buck and try to blame someone else for their faults. Are we really suppose to believe that all they were doing was insuring CDOs purely based on S&P and Moody’s “AAA” ratings? Is that even acceptable? I mean shouldn’t they be doing their own research and analysis themselves if they are insuring billions worth of securities?

According to MBIA 2007 CDO Strategy they were supposedly doing a lot more than just taking the credit agencies word for it:

“MBIA’s approach to underwriting CDOs comprises four primary components: First: MBIA evaluates the proposed collateral pool. For each transaction MBIA reviews the proposed portfolio by performing several analyses of the collateral pool to ascertain its overall credit
quality and also to identify collateral with characteristics outside of norms for its asset class. All proposed corporate portfolios are run through market credit screening tools such as the KMV or Kamakura models to assess the overall credit quality of the pool and to determine if any collateral has a potentially higher default propensity than its current ratings might suggest. The KMV and Kamakura models are important tools used both in the initial review process, as well
as on an ongoing basis over the deal’s life for portfolio monitoring purposes. They estimate credit risk and correlation using equity market data. MBIA also uses one or more credit spread services to assess the overall spread characteristics of the pool to detect any proposed assets with spread wider than its peers by rating band. MBIA also compares the proposed collateral pool to MBIA’s total CDO exposures to ascertain collateral overlap among transactions and the
incremental exposure provided by any single piece of collateral given the subject transaction.
Finally, MBIA’s Corporate Analytics Group provides a fundamental assessment of certain
names in the pool, e.g. names with higher KMV or Kamakura scores (a higher score suggests greater credit risk) or collateral obligors whose spreads are wide relative to peers. Based on its
analysis, MBIA may require certain loans or bonds to be removed from the portfolio and/or that concentrations be reduced relative to industry or specific collateral.”


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