Fro Jerome's The Next Domino (Jan 21st, 2008)

AMBAC, the largest of the monolines, was downgraded this week-end by Fitch, the smallest of the 3 rating agencies (Moody's and S&P are widely expect to follow suite soon), after it emerged that its proposed capital-raising plan would not be seen as sufficient and was cancelled. This means that:

• AMBAC can no longer do any business; clients that were looking to enhance their bonds through them can no longer do so, and will see their borrowing costs increase;
• even worse, all bonds which are already guaranteed by AMBAC will now lose their own AAA rating, which means that all the investors that need to hold a given proportion of such highly rated paper (and there are a lot of them) are going to need to sell that paper, which no longer fits in their portfolio. This could cause a massive drop in their price if they all sell at the same time, losses for many institutions, and more chaos in the financial system.

And there's close to a trillion dollars of such paper around. We're looking at the mother of all financial stampedes here, if and when the monoline insurers are downgraded by the two big rating agencies...