Negotiating from equally desperate positions, the monolines and banks are trying to resolve some ugly business. Lavonne Kuykendall (Dow Jones Newswires 6/23/08 15:44 ET) reports that Ambac (ABK), MBIA (MBI), Security Capital Assurance (SCA), and Financial Guaranty Insurance Corp. (called FGIC) are trying various methods to cancel credit default swap (CDS) contracts on collateralized debt obligations (CDOs). So far efforts to cancel the contracts by claiming misrepresentations have not been successful in court. Merrill Lynch (MER) defeated Security Capital attempts on seven contracts for $3.1B in face value.

DJ reports the total monoline CDS exposure is to guarantee payments on $125B in CDOs. As the monolines started losing their triple-A ratings, the banks have either written down the underlying CDOs or moved them from held for sale to held for investment. Now that all of the legacy monolines have lost their triple-A, the banks are concerned they will incur additional large reserves. Even though the banks are facing the inevitable counter party risk, they still have been reluctant to accept buyouts.

The tides may be changing. Once banks are forced to increase capital against their insured CDOs they have nothing left to lose in accepting buyouts. Getting some money from the monolines is better than forcing them into rehabilitation (receivership). ACA Capital Holdings (ACAH) closed three contracts for a payment of $28.4M.

The pressure on the monolines is also increasing. Once MBIA lost its triple-A, it faces $2.9B in termination payments and $4.5B to collateralize its guaranteed investment contracts (GIC) - a total of $7.4B. Ambac will have to put up $556M.

Standard & Poor’s (MHP) says that the monolines risk their reputations pursuing buyouts based on their weak positions. It will lessen the value of their insurance to future customers. I think with all the cards now out on the table, the time for saving face is over. The monolines need to clear their books and regain their triple-A credit rating. With that the customers will return.