Failure by design

The markets are rallying on news that billionaire investor Warren Buffett has offered the three largest bond insurers, a plan to reinsure $800 billion in municipal bonds. The three companies are: Ambac Financial Group Inc., MBIA Inc. and Financial Guaranty Insurance Co.

Bond insurers write policies that protect bondholder’s payments in case the bond issuer defaults. Buffett has made it clear he will not invest in the bond insurers, but is offering to insure part of the risk these bond holders took on. The municipal bonds that Buffett has chosen are fairly safe and are not the cause of the current credit crisis. The CDO’s that are causing the bond insurers so much grief lately are not part of Buffett’s plan.

Buffett’s move is more of an act of good faith, helping to restore confidence in the economy and providing the bond insurers with additional revenue. Several bond insurers have seen dramatic drops in share price, such as ACA Capital Holdings (OTC: ACAH). ACAH has seen there share price drop from $15 to $0.65 on credit rating downgrades and losses spurred by higher than expected defaults in the CDO market.

Bond insurers rely heavily on their credit ratings to get new business and the recent troubles in the credit markets have caused several rating agencies to start considering downgrades. A downgrade of a bond insurer is essentially a downgrade of all the bonds issuers that they have covered, and is generally a sign of increased downside risk.

If you liked this article feel free to check some other finance articles here at Thiagoavila.com and at Bluemoat

Well I was reading this article the other day by a Harvard economics professor writing about a woman who after taking a job paying $10000 more, wound up with much less disposable cash. The author goes on to show that the reasons for this are the loss of free health care coverage, child benefits, housing subsidies and tax breaks. (more…)

Traditionally and even in some macroeconomics courses, it is said that individuals act rationally and consider all known information in the decision-making process. Traders today know this is not true. In a world where financial institutions and hedge funds use 200-300:1 leverage and markets swing wildly, there is plenty of emotion and irrational behavior to go around. Winning traders and investors make money by consistently exploiting irrational behavior, whether is it shorting a stock that just got ahead of itself, or by buying dips that happen when people panic sell.

Human emotion is a major factor in the stock market, as you have probably felt all of these:

Hope: I hope it goes back to where I bought in, I just want to break even

Fear: It has gone down everyday for the last week, I don’t want to lose everything

Greed: It just keeps going up, I should double up. How can I lose?

Despair: I just keep losing money, maybe I should quit. (more…)

At the day of every FED meeting, the markets are almost always volatile. Traders on the bond and equity markets are speculating on whether the Federal Reserve will cut the Fund rate, and take positions accordingly. The Fed fund rate is the interest rate at which private institutions lend federal funds to other institutions. It is one of the open market operations that the Federal reserve can use to control the money supply. Many interest rates are calculated based on the Fed fund rate, and lowering this rate decreases the cost of borrowing money. Corporations reduce their interest rate costs associated with debt they have incurred or can borrow cheaper when the Fed rate drops.

Now, is the announcement random? Read the rest of my post at Bluemoat Financial