The Short View: Credit crisis returns

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On Thursday, the market’s worst fears were realised. MBIA and Ambac Financial, the two biggest monoline bond insurers, lost their triple A credit rating from Standard & Poor’s.

Had this happened at any point in the first three months of this year, when the entire stock market appeared to be ebbing and flowing on the fortunes of the monolines, it would have started a rout.

But thankfully, the markets’ fears have moved on. The monolines were no longer the apex of worry. They have an important role in the financial system, as the guarantors of a range of asset-backed securities, but banks and financial groups have used the last few months to reduce exposure to those securities. This dents their profits, but makes them less vulnerable to disaster.

As a result, stock markets actually registered significant gains on Thursday. Remarkably, those gains even extended the stocks of the monolines themselves, which shot up after a momentary sell-off on the announcement of the downgrade – presumably because short-sellers took this as the cue to take profits, buying back stock in the process.

The incident also nicely encapsulates evolving sentiment toward the credit market. The firesale of Bear Stearns in March took “Armageddon” (a systemic financial crisis) off the table.

But the recovery in credit since then, on both sides of the Atlantic, has petered out and gone into reverse in recent weeks. Financial stock indices, meanwhile, have hit fresh lows for the crisis. They are even lower than in March.

So the market seems now to believe that credit problems will not go away, but will damage financial companies’ profits (and their shareholders), rather than cause the collapse of a major bank. So credit declines slightly, bank stocks fall sharply – and the monolines get downgraded without sparking a rout.

john.authers@ft.com

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