Marc Faber: Investors Shouldn’t Be Buying
Source:
Marc Faber Interview
Bloomberg, June 9, 2008
Marc Faber spoke to Bloomberg Television by phone earlier today and had the following to say:

Obviously, the economy is already in recession. Corporate profits will disappoint. In particular, the consensus earnings for 2009 are still far too high. And after jobs creep downward, obviously valuations look less compelling.

Well, I would say, what we are in, is kind of a water-torture bear market. A lot of stocks peaked out already in 2005, like to homebuilders. And in 2006, the subprime lenders. Then in 2007, all financial stocks… And I think the cyclicals, and the energy, and the materials stocks, like steel and iron ore companies, they will now all come under pressure… but I think other sectors of the market that have held up well are now vulnerable.

On what investors should be buying, Dr. Faber, who is known for advising clients to get out of the U.S. stock market one week before the October 1987 crash, said:

I think the question should be, what sector should you sell… I don’t see any compelling value in equities. I also don’t see any compelling value, in say, real estate, or in the commodity market. I think asset markets are still inflated. And we are in an environment, contrary to the last 25 years, during which leverage increased. We are in a period of deleveraging.

Responding to the question of whether or not investors should park their money in cash, the editor of the Gloom Boom & Doom Report said:

Well, cash is not desirable in the sense that it loses its purchasing power because you have a money printer at the Fed, Mr. Bernanke… His monetary policy inevitably is inflationary, and as a result, leads to a lower dollar.

When Bloomberg asked if high oil prices were unjustified, the Swiss-born investment adviser said:

My view would be that commodities will rather ease, as some have already done…

(On oil) The big upside is now gone. And so I would be a little bit careful about blindly buying commodities. I think they’re on the high side, the way real estate was on the high side, the way stocks were on the high side. I would not short commodities, but I would be careful about buying them here.The dollar has some upside potential here. But of course, if Mr. Bernanke continues to print money and push down the Fed funds rate to zero, then the dollar won’t go anywhere. As of today, I believe the dollar is relatively undervalued with the euro. I still like gold (transmission garbled)…

Finally, Dr. Faber had this to say when asked to pick one investment for next 6 to 12 months:

Well, I would take a holiday and forget about the speeches of Fed governors, because their economic knowledge, is in my opinion, is extremely limited. And each time they speak, they actually confuse the issues. And so, there is very little sincerity, at the present time.

Excerpt: "I was going to call this "Banks March Us Into Depression," or maybe more fitting is . . . "Complete Collapse of US Banking System." Folks, that is what we are looking at. I don't see any way around it. What we're seeing here in Florida, is your crystal ball. And what happens here, is coming to a town near you . . . soon. This past week I didn't write anything, because what I am seeing unravel is disturbing to the point I had to question what I was seeing and hearing. So I decided to take as much time as I needed to digest it all, and then put something together for you. So here goes . . .

I could prepare volumes of spread sheets with Bernankesque numbers. I could talk about commodity prices and oil and third world politics and a dozen other metrics that all lead to the same conclusion. But let me give you a ground zero look. That's what I do best. I will leave the manipulation of the numbers to the folks on Wall Street that do it best. The same folks that have created the precipice they will soon push us off.

I spend a great deal of time dealing with Asset Managers hired by banks stuck with REOs. So as not to re-hash the events leading to the housing crisis, I will not discuss the free-money policies of the past, and I will not discuss the absolute lack of accountability in making the bad loans of the past. Let's just deal with how the banks are attempting to recover.

Unfortunately, banks are not making a realistic effort to address the crisis. That may be because they cannot. As the banks and builders have announced write down after write down, my mantra has been . . . and continues to be . . . NOT ENOUGH - NOT ENOUGH - NOT ENOUGH. I still believe that. The builders and the banks have underestimated the magnitude of the problem, and they continue to do so. Analysts continue to look at the rear-view mirror and attempt to manipulate numbers based misguided historical assumptions." Full article floridacrystalball

A DERIVATIVES expert who two years ago warned of a potential meltdown in global credit markets has cautioned that the crisis is far from over, and has endorsed recent calls to relax controls on inflation and allow higher prices to help markets trade their way out of their problems.  Longtime critic of derivatives markets, Satyajit Das, says those who believe the US sub-prime loans crisis, and the drought in credit markets it triggered, are nearly over are wrong.

Full article:  das0508

Es gibt jedoch zwei Aspekte, die mit Abstand die größte Bedeutung haben: Negative Equity und Deleveraging. Man kann sicherlich Negative Equity auch als Leverage-Problem ansehen. Ich werde im folgenden jedoch beide Aspekte getrennt voneinander betrachten:

Deleveraging bezeichnet das Gegenteil von Leveraging. Es bezeichnet also den Abbau von Fremdkapital bzw. Aufbau von Eigenkapital. Resultat ist eine Reduzierung der Leverage-Quote. Retailbanken haben zum Beispiel in der Regel eine Leverage-Quote von 10-12; Investmentbanken zwischen 20-25. Jan Hatzius, Chef-Volkswirt von Goldman Sachs, beschäftigt sich in einer Studie mit den Auswirkungen des Deleveraging (Deleveraging Paper). Für alle, die Herrn Hatzius nicht kennen: er ist einer der ganz wenigen Ökonomen gewesen, der bereits im letzten Jahr auf die Krise hingewiesen hat. Seine Studien sollte man sich daher immer genauer anschauen:

"There is a positive relationship between changes in leverage and changes in balance sheet size. Far from being passive, financial intermediaries adjust their balance sheets actively and do so in such a way that leverage is high during booms and low during busts. Leverage is procyclical in this sense. ....Procyclical leverage can be traced directly to the counter-cyclical nature of value at risk. Leverage is high when value at measured risks are low – which occurs when financial conditions are buoyant and asset prices are high. Leverage is low in the troughs of the financial cycles, reflecting increased volatility of asset prices as well as increased correlation of asset returns."

Geringere Leverage-Quote bei Banken führt zu geringerer Kreditvergabe. Dies hat natürlich gewaltige Auswirkungen auf das GDP:

"As a back of the envelope calculation, we can use the estimate from Exhibit 5.2 along with the potential $910 billion contraction in end-user credit to calculate a GDP effect from the deleveraging. This contraction is equivalent to a 3.0-percentage-point drop in DNFD growth. The results in Exhibit 5.2 imply that this corresponds to a hit to real GDP growth of 1.3 percentage points over the course of the following year. This impact should be viewed as additive to the impact of housing on real GDP growth via other channels, such as the decline in residential investment and any potential wealth effects tied to falling house prices. We emphasize that the calculation is very rough, and should be viewed as quite speculative. But, it does suggest that the feedback to the economy from the deleveraging could be substantial."

Die GDP Reduzierung durch Deleveraging allein wird also seiner Meinung nach 1,3% betragen. Dies ist in meinen Augen sehr konservativ geschätzt, zumal zwei Aspekte in der Studie nicht berücksichtigt worden sind: erstens, werden wir aufgrund von Moral Hazard Problematik im Underwriting historisch hohe Ausfallraten im Mortgage-Geschäft sehen. Der Boom im Verbriefungsmarkt hat nämlich dafür gesorgt, dass die Bonität des Keditnehmers eine viel geringere Rolle als historisch üblich gespielt hat. Dementsprechend müssten seine Abschreibungsannahmen eigentlich höher sein, was wiederum zu einer größeren Kreditkontraktion führt (und damit GDP Reduzierung um mehr als 1,3%) . Zweitens, wurde nicht auf den Leverage von Hedge Funds eingegangen. Auch dieser wird derzeit deutlich zurückgefahren. Das Hedge Fund Sterben ist derzeit nämlich in vollem Gange (siehe die Immobilienpreisentwicklung der letzten 3 Monate in Connecticut). Dadurch werden generell Spreads in den nächsten Jahren höher werden. Dies wiederum bedeutet, dass die Finanzierungskosten für Unternehmen deutlich wachsen.

Negative Equity liegt vor, wenn der Hauskredit höher ist als der aktuelle Wert des Hauses. Im Gegensatz zu den meisten europäischen Ländern hat der Kreditnehmer in den USA sogar die Option, den Kredit gegen das Haus einzutauschen. Dies macht natürlich nur im Falle von negative Equity Sinn. Dann hat er nämlich sozusagen eine im Geld stehende Put-Option. Auch hierzu liefert Hatzius interessante Zahlen:

"About 7% of U.S. mortgage holders had negative equity at that point. Another 4% had equity of 0%-5%, and 5% each had equity of 5%-10% and 10%-15%. Thus, the proportion of mortgage holders with negative equity would rise to 11% given a (uniform) home price decline of 5%, 16% given a drop of 10%, and 21% given a drop of 15%.8 These are very large numbers. There are approximately 50 million households with mortgages in the United States, so 21% of all mortgage holders corresponds to about 10.5 million
households. If negative-equity homeowners on average have mortgage debt of $250,000, this would imply that a 15% home price decline would put about $2.6 trillion of mortgage debt “under water.”"

Durch die im Geld stehende Put-Option ergeben sich demnach weitere Verluste für Banken. Je nachdem welche "Umtauschraten" man annimmt, kommt man dann zu einer unterschiedlichen Höhe von Verlusten (Nouriel Roubini setzt die in meinen Augen immer sehr hoch an - das soziale Stigma wird da in meinen Augen unterschätzt). Aber unabhängig von der genauen Verlusthöhe ist die Fokussierung auf die Bankverluste als solches falsch. Kernproblem ist der Vermögensverlust (durch geringeren Wert des Hauses) des Durchschnittsverbrauchers (derzeit 2 Billionen USD allein in den USA). Da dieser derzeit zusätzlich noch eine historisch hohe Verschuldung hat, gibt es für diesen nur eine Konsequenz: viel weniger konsumieren! Aufgrund des Konsum-Stopps werden wir eine äußerst schwere Rezession in den USA (und auch in anderen Ländern) sehen. Dies kann man bereits deutlich am Einzelhandelsgeschäft ablesen (jüngstes Beispiel J.C. Penny). Andere Möglichkeit ist das aktuelle Verbrauchervertrauen. Hierzu schreibt JPMorgan:

"Consumer confidence sank much lower than projected, falling to 64.5 in March from 76.4 in February. The expectations component of the survey was abysmal, falling to its second-lowest reading on record; the previous low was in December, 1973, the first month of one of the worst recessions in the post-war era. Of the three expectations questions – on business conditions, employment, and income – each looked horrible but the income question was worst of all, sinking to a new low."

Bemerkenswert dabei ist, dass wir gerade erst am Anfang des Downturns sind. Die Arbeitslosigkeit beginnt gerade erst zu wachsen. Ich gehe daher davon aus, dass das Verbrauchervertrauen auf den Stand der 30er Jahre fallen wird. Konsum-Stopp wird bald die zwangsläufige Devise für den Durchschnittsverbraucher sein.

Negative Equity und Deleveraging sind die Hauptgründe für die Weltwirtschaftskrise 2008. Die Mainstream Medien (Spiegel Online, Handelsblatt,..) werden das wahrscheinlich erst in einem Jahr einsehen. Nur sind dann die Aktienindizes bereits viel weiter gefallen (und dann werde ich langsam auch wieder bullish).

Financial, and home-building stocks were strong, while oil/gas, fertilizers, and steel stocks were weak. Monsanto lost 12%. Bidu.com's recent rally was killed today when it lost 11%. Buenaventura (BVN) lost 10% as gold stocks sold off hard. Potash Sask. and National Oilwell Varco lost 10%.

Investors are running for the cover of US short-term treasuries in what could be described as a "panic" out of assets. The yield on the 3-month T-bill got as low as only 0.3% today. Has a massive "de-leveraging" begun? I hope not because there is an estimated $516 trillion in leveraged derivatives.

It was announced today that Fannie Mae and Freddie Mac's reserve requirements were lowered from 30% to 20% and that $200 billion is available for purchasing mortgages. It's estimated that this gives them the ability to buy or guarantee a massive $2 trillion in mortgages. In my opinion this is now putting 'crap' mortgages on the books of the US (and us, the taxpayers).

If the Federal Reserve plans to bail out every major financial institution that's in trouble this could well run into the trillions of dollars. With real estate prices collapsing 20% since this summer in southern California and sizable losses in other 'bubble' areas like Florida, Nevada, Arizona, etc., this is threatening to take down the financial system as we know it.

The Fed is also signaling that it will do what ever it takes and will add more liquidity if needed. Will this 'tsunami of liquidity' be enough to help the $11 trillion US mortgage market? Can it save scores of shaky banks, brokerages and over-leveraged hedge-funds like Carlyle Capital ($21 billion fund who used 32:1 leverage!) from imploding?

With home prices dropping, some small business owners are now left with properties worth less than the money they owe the banks.

"Businesses have taken on large amounts of debt over the past several years, which they are probably having trouble refinancing since banks are tightening their lending standards," said Carol Kaplan, a spokeswoman for the American Bankers Association (ABA).

A lot of small businesses are also seen likely to take on too much credit card debt that may ultimately push them under.

Marilyn Landis is president of Basic Business Concepts Inc (BBC), a Pittsburgh company that performs the tasks of a chief financial officer for small businesses that require more than a bookkeeper but do not yet need a full-time CFO.

She said a lot of small companies will suffer the consequences of Wall Street's lax lending practices.

"There are many companies out there that borrowed money against their homes without a solid business plan," she said. "I've had to turn down potential clients who are way out of their depth with debts."

Landis added she had been planning to expand into Michigan this year, but is going to "take a hard look at those plans given the current economic environment."

TIGHTER STANDARDS

According to the Federal Reserve's January Senior Loan Officer Opinion Survey -- which included 56 domestic banks and 23 foreign banking institutions -- 30.4 percent of respondents said they had "somewhat" tightened lending standards on commercial and industrial loans to small, medium-sized and large firms, up from only 5.3 percent a year earlier.

"That's a significant change," ABA's Kaplan said.

In the same survey, 30.9 percent of banks said they had seen "moderately" weaker loan demand from small firms, up from 21.4 percent a year earlier.

Not everyone agrees that small businesses are finding it harder to gain access to loans.

"There is no credit crunch on Main Street for small businesses. Period," said William Dunkelberg, chief economist of the National Federation of Independent Business (NFIB).

Regular monthly NFIB member surveys show little change in respondents' perceptions of how easy it is to obtain credit.

But Dunkelberg and the NFIB seem to be in a minority.

Alan Tonelson, research fellow at the U.S. Business and Industry Council said small manufacturers are especially reliant on bank financing since they have only modest profits to put toward growth and are thus more likely to suffer now.

"Margins throughout manufacturing have become so thin that reinvestable capital has dried up," he said, citing competition from Chinese producers.

"If they're still in business after all this, chances are they're extremely well run," he said.

Josh Frey, owner of Onsalepromos.com based in Washington, D.C., with a staff of six, said he had hoped to add about five employees annually for the next several years, plus find office space capable of accommodating up to 25 workers.

Frey approached his lender, a "huge" national bank which he declined to name, for a $250,000 credit extension.

"They wouldn't do the line of credit against the assets of the business," Frey said. The bank wanted his home, in which he has built up a lot of equity, as collateral.

Frey refused, wanting to keep personal and business finances separate.

"I got nothing because I wasn't willing to collateralize it with my house," Frey said.

With access to traditional loans limited small businesses are expected to turn to credit cards, which carry much higher interest rates.

The Fed's 2003 Survey of Small Business Finance -- conducted every five years -- found 48 percent of small companies used business credit cards, up from 34 percent in 1998.

BBC's Landis said she has used business credit cards to expand her operations and has noticed her rates rising, which her banks attribute to higher credit risk in the market.

"In the coming months we'll see a lot of companies hunkering down and choosing not to expand," she said. "Others will use credit cards to bail themselves out, which will push them further and further into debt."

That's quite a change from the recent past when median returns topped 20 percent for buyout funds raised from 2000 to 2004, according to London-based Private Equity Intelligence. For pension funds in particular, these holdings outperformed their other investments 82 percent of the time when looking back over the last 10 years, Preqin data found.

Those returns caused a flood of cash to flow into buyout funds, which raised an aggregate $210 billion in 2007, on top of the $233 billion raised the year before, Preqin found.

That money, along with easy access to cheap debt financing, fueled the record-setting pace of dealmaking in recent years. But triggered by surging defaults on home loans, lenders have tightened the credit tap for businesses and consumers, and that's spurred a flight to quality by debt-market investors.

"People are worried that the economy is facing a difficult time," said Steve Miller, managing director at Standard & Poor's Leveraged Commentary & Data. So "investors have repriced risk to cushion if default rates start to really go up."

That's most evident in leveraged loans, which are issued by banks and sold to investors much like junk bonds. They are often used to fund leveraged buyouts, but given the downturn in investor interest, the banks have been left with $150 billion overhang of LBO debt on their books.

Morgan Stanley's chief financial officer Colm Kelleher told an investor conference on Wednesday that the investment firm's $20 billion of leveraged-buyout loan commitments are its "top concern right now," according to a transcript provided by Thomson Financial.

At the same time, much of the LBO debt trading in the marketplace has been plunging in value, suggesting a buyers' strike by investors worried about how close we are to the bottom of the credit crisis. The tumbling prices can also indicate that investors are worried that bankruptcy could loom at some companies.

The Distressed Debt Investor found that 29 percent of 176 bonds and loans tied to U.S. LBOs from 2002 through the third quarter of last year, when this market began to seize up, are trading at distressed levels. Those are bonds with option-adjusted spreads at least 10 percentage points above Treasury yields or loans trading at 90 cents or less on the dollar.

That's way ahead of the nearly 19 percent level of distress seen in the broad-market Merrill Lynch Master II High-Yield Index, according to the publication put out by FridsonVision.

One example is Claire's Stores, which was taken private by Apollo Management in a $3 billion deal last May. The Pembroke Pines, Fla., jewelry and accessories retailer's bonds have slumped in recent months, amid a weakness in its sales.

Its senior notes due in 2015 have plunged 33 percent to trade around 67 cents on the dollar. And its subordinated notes are trading around 48 cents on the dollar, according to bond research firm KDP Advisor in Montpelier, Vt., which is recommending its clients sell their Claire's Stores' debt.

The price of Tribune Co.'s debt is also sharply lower; weakening economic conditions are knocking down advertising revenues throughout the newspaper industry. The media company, taken private by investor Sam Zell for $8.2 billion in a deal that closed in December, issued $5.15 billion in loans that are now trading at about a 27 percent discount, according to S&P LCD.

Zell's investment in Tribune was $315 million and he owns warrants to buy about 40 percent of the company, which will be formally owned by an employee stock ownership plan.

Many others, including data processor First Data Corp., real estate broker Realogy Corp. and Freescale Semiconductor Inc., have also seen their LBO debt battered in recent months.

The plunging prices don't put the buyout firms in a good spot. Many made their purchases at the height of the buyout boom, making it questionable if they'll ever see their original valuations again.

Some will likely try to wait out the market's storm before they try to sell the investments off, but others might not have that luxury. That's where this could get ugly — for all of us.

    imf01292008.pdf

http://www.boston.com/bostonglobe/ideas/articles/2008/01/27/the_black_box_economy/

Here is text of the letter: 
January 18, 2008

Mr. Raymond McDaniel Mr. Stephen Joynt
Executive Chairman and CEO CEO and President
Moody’s Corp. Fitch Ratings
99 Church St. One State Street Plaza
New York, NY 10007 New York, NY 10004

Mr. Deven Sharma
President
Standard & Poor’s
55 Water Street
New York, NY 10041

Re: Bond Insurer Ratings

Ladies and Gentlemen:

As a Nationally Recognized Statistical Rating Organization, Moody’s, S&P, and Fitch
have been granted a level of authority that capital market participants and Federal and
State regulators have historically relied upon in evaluating the safety and soundness of
corporations, regulated financial institutions, and structured finance securities. To state
the obvious, because of your critical role in the capital markets, it is essential that the
ratings you publish are the result of comprehensive and accurate analysis.

As you well know, we have privately, in meetings and correspondence with you, and
publicly in various presentations that we have made, called into question your ratings of
the bond insurance industry, in particular, the ratings for MBIA Insurance Corp. and
Ambac Assurance Corp. and their holding companies.

Each of you, according to your recent public statements, is in various stages of updating
your ratings of the bond insurers. Unfortunately, however, your previous ratings
assessments have erred materially in their omission of certain critical analysis and the
inclusion of outright errors in your work. As you conduct your most recent revisions of
your analysis on the bond insurers, it is vital that you conduct a thorough assessment of
all aspects of the bond insurers’ business lines, their reinsurers, and investment portfolios

so that the rating decisions that you ultimately publish can be relied upon by capital
markets participants.

Below we highlight a number of factors that you have failed to consider in your prior
assessments of the bond insurers’ capital adequacy:

1) Impact of Losses Should be Measured on a Pre-tax Basis

We believe that each of you overstates the bond insurers capital cushion due to tax
benefits you include in calculating the impact of RMBS and CDO losses. For instance, in
S&P’s recent press release update published yesterday, MBIA’s losses on RMBS and
CDOs are expressed as “after-tax” losses. In order, therefore, to determine the actual
cash losses implied by S&P’s after-tax estimate, one must gross up the reported $3.18
billion of after-tax losses. Assuming a tax rate of 38%, it appears that S&P is estimating
MBIA’s actual cash losses at $5.13 billion, nearly $2 billion more than the losses
adjusted for tax benefits.

Insurance claims must be paid in cash. A bond insurer is only able to obtain tax benefits
if the insurer is a going concern and is able to generate sufficient taxable income in the
current or future years to offset the losses from paid insurance claims. Your analysis
makes the aggressive assumption that the bond insurers will remain going concerns and
will therefore be able to continue to write new premiums and generate income in the
future.

Based on recent industry developments – including Berkshire Hathaway’s entrance into
the business – it appears unlikely that MBIA, Ambac and many of the other bond insurers
will be able to continue as going concerns. In a runoff scenario, we do not believe that
the bond insurers will generate sufficient taxable income to offset the net operating losses
generated by paid losses. While U.S. corporations can receive tax refunds by carrying
back tax losses up to two calendar years, the amounts that could be refunded from
carrying back losses are de minimis relative to claims payable. Even in the event the
bond insurers generate taxable income in future years, it may be many years before these
tax benefits can be realized, if ever, particularly in the event of corporate ownership
changes caused by capital raising or stockholder turnover.

Net operating loss carryforwards are not cash and are not available to pay claims and
should therefore not be deducted from losses in calculating bond insurer capital
adequacy. By using after-tax loss estimates rather than pre-tax losses – the amount that
will need to be paid in cash – you are understating the actual losses payable by more than
60%.

Your updated rating assessments should be adjusted to exclude tax benefits in your
calculation of capital adequacy

2

2) Covenant Violations and Loss of Access to Liquidity Facilities

As a result of recent losses, both MBIA and Ambac have triggered covenant violations on
their liquidity facilities. As a result, Ambac has lost access to $400 million of funding
and MBIA to $500 million of capital. The impact of the loss of these facilities is material
to the liquidity profile of the holding companies and their insurance subsidiaries and must
be considered in your credit assessment.

3) Loss Estimates Must Incorporate Reinsured Exposures

Your ratings of the bond insurers are based on the bond insurers’ net credit exposures.
That is, you reduce their credit exposure by those exposures that have been reinsured.
This is best understood by example.

As of September 30, 2007, MBIA has re-insured approximately $80 billion of par value
of its exposures. More than $42 billion of this reinsurance was purchased from Channel
Re, a Bermuda- based reinsurer whose only customer is MBIA. The two most senior
officers of Channel Re are former executives of MBIA. MBIA owns 17% of the
company and has two representatives on Channel Re’s board of directors.

On recent conference calls, Moody’s and S&P have stated that they have not yet updated
their ratings of the monoline reinsurers including Channel Re. Earlier this week, on
January 16th, Partner Re and Renaissance Re, the majority equity owners of Channel Re,
wrote off the entire value of their investments in Channel Re due to losses it has recently
incurred that substantially exceed Channel Re’s capital, an impairment that Channel Re’s
two majority owners have concluded is “other than temporary.”

Despite the fact that Channel Re has negative book equity and $42 billion of MBIA’s
credit exposure – $21.5 billion of which is CDOs of ABS or CLO/CBOs – Moody’s and
S&P continue to rate the company Triple A with a stable outlook. Fitch does not rate
Channel Re and apparently relies on S&P’s and Moody’s stale Triple A ratings in its
analysis of MBIA’s capital adequacy.

Captive reinsurers whose ratings are not regularly updated offer the potential for abuse.
We believe that MBIA reinsured on a quota share basis 25% of its 2007 CDO
transactions with Channel Re. As a result of Moody’s and S&P not updating its ratings
of Channel Re, these exposures do not appear on MBIA’s list of exposures and have not
been included in your calculation of MBIA’s capital adequacy.

MBIA’s second largest reinsurer is Ram Re which has reinsured $11 billion of par as of
September 30, 2007. While the rating agencies have not updated their credit ratings of
Ram Re, the market appears to have already done so. The publicly traded stock of Ram
Holdings Ltd., the parent company of Ram Re, has declined 92% in the last year. The
company currently trades as a penny stock with a market value of $32 million.

3

We believe that Ram Re is substantially undercapitalized and therefore, like Channel Re,
is unlikely to be able to meet its obligations to MBIA.

We also note that MBIA reinsures Ambac, and Ambac reinsures MBIA. You must also
consider the iterative impact of downgrades of one on the other with respect to both
reinsurance and their respective guarantees of each other’s investment portfolio assets
which we discuss further below.

In your updated assessment, it is critical that you update your ratings of the bond
insurers’ reinsurers and reconsolidate and calculate the losses on these exposures that
have been reinsured with reinsurers that are inadequately capitalized.

4) Investment Portfolios are Riskier Than They Appear

As you are well aware, the investment portfolios of the bond insurers include a
substantial amount, often a majority, of bonds that are guaranteed by either the bond
insurer itself or by other bond insurers. The bond insurers include these guarantees in
calculating the weighted average ratings of their investment portfolios. We note that a
minimum average Double A rating is a key rating agency criterion for the insurers’ Triple
A rating.

A guaranty to oneself is of course worthless and therefore you should exclude the bond
insurers’ guaranty of its own investment obligations and use the underlying ratings of
these instruments in determining the portfolios’ credit quality.

You should also carefully calculate the impact of a downgrade of the bonds held by one
bond insurer that are guaranteed by other insurers in your calculation of capital adequacy.
In light of the general distress in the industry, we believe that the rating agencies should
evaluate the bond insurers’ investment portfolios as considered on an underlying rating
basis.

5) Commercial Mortgage Backed Securities (CMBS)

To date, you have limited your analysis to RMBS securities and other structured finance
securities with exposure to RMBS (CDOs). This limited review of exposures ignores the
fact that the same lending practices and flawed incentive schemes that fueled the
subprime lending bubble have been very much at work in CMBS and corporate finance.

On January 17, 2008, Fitch commented that it believed that CMBS delinquencies are
“likely to double, and perhaps even triple, by the end of 2008.” As of September 30,
2007, MBIA had insured $43 billion net par of CMBS securities, the vast majority of
which was underwritten in the past two years. Failing to consider the potential for losses
in this portfolio in your calculation of capital adequacy is simply negligent.

4

6) Claims-Paying Resources Definition Overstates Capital Available to Pay Claims

The rating agencies have adopted the bond insurance industry’s definition of capital in
the form of “Claims Paying Resources” or “CPR.” We believe there are significant flaws
with the calculation of CPR used by the industry and the rating agencies.

First, bond insurers include the present value of future premiums discounted at extremely
low discount rates ~5% in their calculation of claims paying resources. Substantially all
of these premiums are from structured finance guarantees. We believe that the bond
insurers and the rating agencies do not adequately consider the facts that: (1) when
structured finance obligations default, accelerate, or otherwise prepay ahead of schedule
these premiums disappear, (2) purchasers of secondary market guarantees are likely to
terminate their periodic premium payments because of the deteriorating credit quality of
the bond insurers, (3) the reserves for losses on these exposures (for example 12% of
premium for MBIA) have proven to be inadequate and therefore overstate the net
premium income, and (4) there is no provision for overhead, remediation, legal or other
costs required for the bond insurers to run their business going forward. There is also no
mechanism whereby the bond insurers can borrow against these potential future
premiums to be used to pay claims in the present day.

There is no other financial institution in the world which takes the present value of
interest spread income on loans in its portfolio and adds it to its capital. For all of the
above reasons, we believe that the present value of future premiums should not be
included in CPR.

CPR includes the bond insurers’ so-called depression lines of credit. As you well know,
depression lines of credit can only be drawn to pay claims on municipal obligations and
only after a substantial deductible. In that the losses are occurring primarily on structured
finance obligations, these lines of credit should not be included in CPR

The Capital Base included in CPR is also likely to be overstated because the investment
assets of the bond insurers consist primarily of bond insurer guaranteed obligations that
are valued inclusive of the guarantee, when they should be valued on an unwrapped basis.
The high degree of balance sheet leverage for certain bond insurers means that small
changes in the values of these portfolios have a large impact on the bond insurers’ capital
base.

You should adjust your estimate of CPR for each insurer to reflect the above factors in
order to accurately establish the capital available to pay claims.

5

7) MBIA’s $1 Billion Surplus Note Issuance

Last Friday, MBIA priced an offering of surplus notes at par with a 14% yield. Within
one week the notes traded down to the mid-70s and have a yield to call of more than
20%. Previous to their pricing, the notes were rated by Moody’s and S&P at Double A.

The MBIA surplus note issuance is perhaps the clearest example of the failure of the
rating agencies to accurately assess the creditworthiness of a bond insurer. MBIA is still
rated Triple A by all three raters. The notes received a Double A rating because of their
subordination to the other obligations of MBIA Insurance Corporation. That said, how
can a billion dollars of Double A rated obligations sell in a cash transaction between
sophisticated parties at a 14% yield, and then trade to yield of 20% or more — a rate
consistent with a Triple C or near-to-default obligation?

Bank of America 5 ¾% bonds due 2017, obligations of a financial institution that is also
rated Double A, closed today at 5.55% yield, a more than 15 percentage point lower rate
than the MBIA surplus notes. This is prima facie evidence that your ratings of MBIA are
overstated.

Billions of MBIA’s CDO Exposure Require Payment on Default

You have stated that bond insurers have no accelerating CDO guarantees and that all of
their contracts are structured as “pay-as-you-go.” I quote S&P from a paragraph entitled,
“Time is On Their Side,” in their December 19, 2007 report: “Detailed Results of
Subprime Stress Test of Financial Guarantors.”

“As for swap exposure, except for ACA there are no collateral posting

requirements and swaps are written in pay-as-you-go format.”

On January 9, 2008, MBIA filed a copy of a powerpoint presentation which was used in
the Surplus Notes offering road show. On page 8, MBIA states that $8.1 billion of its
Multi-sector CDOs require payment with “Credit events as they occur.”

The liquidity demands of accelerating CDO exposure create extreme liquidity risk and
must be considered in the context of the bond insurer ratings. We encourage you to
examine all of the bond insurers CDS/CDO exposure to determine the amount of
exposure that is not pay-as-you-go, but rather accelerates, and consider the liquidity
demands of such exposures in your rating assessments.

9) Holding Company Liquidity Risk

In light of recent events, we believe it is likely that most bond insurers will be prevented
from upstreaming dividends to their holding companies as a result of regulatory
intervention, as regulators work to preserve capital for policyholders.

6

Most bond insurer holding companies have limited cash, have lost or will lose access to
liquidity facilities, and have substantial cash needs for interest payments, operating
expenses, and dividends (for so long as they continue to be paid). In addition, bond
insurers with substantial investment management or swap operations have additional
liquidity needs in the event of a downgrade.

We believe that both MBIA and Ambac have substantial collateral posting obligations in
the event of a holding company downgrade. For example, MBIA has $45 billion of
derivative obligations at the holding company that relate to currency, interest-rate, and
credit default swaps that the holding company has entered into. The combination of
volatility in each of these markets and the increased collateral demands required in
holding company downgrade scenarios will put a severe strain on holding company
liquidity.

The bond insurers’ muni-GIC business is also a large potential liquidity strain as
municipalities withdraw funds from these GIC programs, assets must be liquidated,
and/or collateral must be posted. Various MTM programs also create liquidity risk as
assets may have to be sold to meet redeeming bondholders. The liquidity risks of these
programs and the underlying assets should be carefully examined.

ACA’s immolation is but one example of what happens to a once-investment grade bond
insurer which, if downgraded, is required to post collateral.

In addition, as a result of shareholder, bondholder, and/or surplus noteholder litigation,
we expect holding company legal expenses and eventual litigation claims to rise
substantially. Because the holding companies typically provide indemnities for
employees and directors, we would expect that directors would be loathe to allow
liquidity to leave the holding company estate, depriving directors and employees of the
resources to protect themselves from claims. In these circumstances, we would expect
companies to seek bankruptcy as a means to protect the allocation of value among
various stakeholders.

10) MBIA - Warburg Pincus Transaction

You have assumed in your analysis that the Warburg Pincus deal and follow-on rights
offering are certainties even though neither transaction has closed. While Warburg has
made affirmative statements about the transaction, both publicly as well as privately, to
surplus note buyers and the media, we believe there continues to be transaction closure
risk for both the initial stock purchase and future rights offering, with the rights offering
having greater uncertainty.

You have also assumed that 100% of the $1 billion Warburg deal will be downstreamed
to the insurance subsidiaries and this, too, is not a certainty. You should receive

7

assurances from MBIA and require it to contribute the full billion dollars to its insurance
subsidiaries before you include the funds in calculating insurance company capital.

With the collapse in MBIA’s stock price and today’s downgrade of Ambac, we believe it
will be difficult for MBIA to execute the rights offering, particularly before the March
31st, 2008 drop dead date. With the stock at $8.55 per share and the market aware that
the $500 million in rights offering proceeds is insufficient to adequately capitalize the
company, it will be difficult to set a market-clearing price. Assuming for a moment the
price is set at $5.00 per share, the company would have to issue 100 million shares and
may sell control to Warburg at a discount in the event shareholders elect not to
participate. We believe a shareholder vote and approved registration statement will likely
be required in such a circumstance, delaying the ability to consummate the transaction
beyond the March 31st Warburg backstop drop dead date.

11) Future Business Prospects and Franchise Value Have Been Irreparably
Destroyed

Following the dramatic decline in share prices, widening of credit protection spreads,
dismal performance of the high yield surplus note issuance, and recognition of multibillion
dollar losses in a supposed “no-loss” business, the ability of bond insurers to
market their “AAA” seal of approval has been permanently undermined. As uncertainty
has grown, municipalities have raised capital without insurance and found that they can
borrow at attractive rates as compared to historical insured bond issuances.

The entrance of Berkshire Hathaway is a devastating competitive reality that will capture
the lion’s share of an already shrinking market for municipal bond insurance. While
some commentators have suggested that this might create a pricing umbrella that will
benefit the existing bond insurers, this is demonstrably false. Because Berkshire
Hathaway already possesses a real Triple A rating, the bonds that are wrapped with its
guarantee will trade with a tighter spread when compared to a bond insured by a
traditional bond insurer, even one without legacy structured finance exposure.

Consequently, Berkshire will be able to charge higher premiums than the other monolines
by taking a higher percentage of the spread (perhaps as much as 80% or more) that is
saved through the use of insurance, and still provide the issuer with an overall lower cost
of borrowing that if they bought insurance from a traditional monoline. As such, we
believe that Berkshire Hathaway will likely quickly reach an 80%-90% market share of
municipal bond insurance.

12) Going Concern Opinion

In light of all of the above and other current developments, we believe it will be difficult
for MBIA, Ambac, and certain other bond insurers to obtain going concern opinions from
their auditors. You should consider the likelihood of the insurers’ obtaining clean
opinions and the implications if they do not in your rating assessments.

8

Lastly I encourage you to ask yourself the following question while looking at your
image in the mirror:

Does a company deserve your highest Triple A rating whose stock price has
declined 90%, has cut its dividend, is scrambling to raise capital, completed a
partial financing at 14% interest (now trading at a 20% yield one week later), has
incurred losses massively in excess of its promised zero-loss expectations wiping
out more than half of book value, with Berkshire Hathaway as a new competitor,
having lost access to its only liquidity facility, and having concealed material
information from the marketplace?

Can this possibly make sense?

Please call me if you have any questions about the above. As usual, I will make myself
available at your convenience.

Sincerely,

William A. Ackman

cc:
Moody’s Corp.:

Andrew Kimball
Ted Collins
Jack Dorer
James Eck
John Goggins
Linda Huber
Naomi Richman
Stanislas Rouyer
Ranjini Venkatesan

Fitch Group:

Thomas Abruzzo
Ralph Aurora
Gloria Aviotti
Robert Grossman

9

Peter Jordan
George Masek
Paul Taylor

Standard & Poor’s:

Edward Emmer
Robert Green
Dick Smith
Vickie Tillman
David Veno

Securities & Exchange Commission:

Ms. Linda Thompson
Director
Division of Enforcement
Securities & Exchange Commission
100 F St. NE
Washington, D.C. 20002

Mr. Mark Schonfeld
Regional Director
New York Regional Office
Securities & Exchange Commission
3 World Financial Center, Suite 400
New York, NY 10281-1022

Mr. Steve Rawlings
Securities & Exchange Commission
3 World Financial Center, Suite 400
New York, NY 10281-1022

New York State Insurance Department:

The Honorable Eric Dinallo
Superintendent of Insurance
State of New York
Department of Insurance
25 Beaver St.
New York, NY 10004

Mr. Kermitt Brooks
State of New York
Department of Insurance
25 Beaver St.
New York, NY 10004

10

Wisconsin Office of the Commissioner of Insurance:

Mr. Sean Dilweg
Commissioner of Insurance
State of Wisconsin
Office of the Commissioner of Insurance
125 South Webster Street
Madison, WI 53703

Bermuda Monetary Authority:

Mr. Matthew Elderfield
Chief Executive Officer
Bermuda Monetary Authority
BMA House
43 Victoria Street
Hamilton HM 12
Bermuda

United States House of Representatives:

The Honorable Barney Frank
United States House of Representatives
2252 Rayburn House Office Building
Washington, D.C.

_uacct = "UA-2215489-1"; urchinTracker();

My idea:  let the ratings companies (Fitch, Standard & Poors, et al.) who bestowed AAA ratings to this mess.  Perhaps they should disgorge all the revenue they collected as a result.  Seems as if they were unjustly enriched at the expense of .... all of us?

So - who spilled the beans?  Well, for one, former ACA Capital honcho (now literally put out to pasture?) as quoted at length in Bloomberg:

"Municipal bond insurers such as MBIA Inc. and Ambac Financial Group Inc. had a good thing going.  For years, they earned some of the highest profit margins in any industry -- by writing coverage for securities sold by states and cities to build roads, schools and firehouses. 

<snip>

`Played With Fire'

``I knew that if they played with fire long enough, they were going to get burned,'' says Fraser, 66.

He left the company in 2001 over a dispute with the board about insuring CDOs, he says. Back then, it was debt of Enron Corp. and WorldCom Inc. -- companies that later filed the two largest bankruptcies in U.S. history -- that was being shoveled into CDOs.

``Companies that were having problems or were growing very fast began to turn up in all the deals ACA was offered,'' says Fraser, who moved to Wyoming to run a 12,000-acre (4,856- hectare) ranch and turn a ghost town into a museum of the Old West.

Fraser, who first rated MBIA and Ambac in the 1970s as an analyst at S&P and later helped turn Fitch into one of the three major rating companies, says that while ACA's original mission had been to help finance projects such as nursing homes and rural hospitals, the board didn't want to allocate the capital needed to insure riskier municipal bonds.

Credit Default Swaps

Backing CDOs with credit-default-swap contracts was more alluring, Fraser says. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a borrower's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should the borrower fail to adhere to its debt agreements.

By using swaps, ACA wasn't limited to guaranteeing only securities with a lower credit rating than its own. It could compete with AAA-rated insurers to back top-rated CDOs while having to maintain less capital than the triple-A companies. The top-rated insurers collected annual premiums for insuring CDOs with swaps that were 50 percent of the capital the rating companies required them to maintain, S&P said in a July 2007 overview of the bond insurance industry. ACA was scooping up premiums that were 130 percent of its required capital.

`Very Low Risk'

``ACA has had good success assuming exposure to very low risk supersenior CDO tranches, where the goal of the counterparty is risk transfer and the associated mark-to-market relief,'' S&P said.

By December, after S&P completed a ``stress test,'' it projected more than $3 billion of losses on those low-risk securities. Alan Roseman, ACA's CEO, didn't return a voice mail message seeking comment."

http://www.bloomberg.com/apps/news?pid=20601109&sid=aw1Oh4B0Wvv8&refer=home

 isda-market-survey-historical-data.pdf

 In ISDA's 2007 survey of collateral, they found that 59% of derivative transactions were secured by collateral agreements, and that 59% of mark-to-market credit exposures were covered by collateral agreements.