The New York Times-20080124-Next on the Worry List- Shaky Insurers of Bonds
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Next on the Worry List: Shaky Insurers of Bonds
Even as stocks ended five days of losses with a surprising recovery on Wednesday, officials began moving to defuse another potential time bomb in the markets: the weakened condition of two large insurance companies that have guaranteed buyers against losses on more than $1 trillion of bonds.
Regulators fear a possible chain of events in which the troubled bond insurers, MBIA and Ambac, might be unable to keep their promise to pay investors if borrowers default on their debt.
That could leave the buyers of the bonds -- including many banks and pension funds -- on the hook for untold billions of dollars in losses, shaking confidence in the financial system.
To avoid a possible crisis, insurance regulators met with representatives of about a dozen banks on Wednesday to discuss ways to shore up the insurers by injecting fresh capital, much as Wall Street firms have turned to outside investors recently after suffering steep losses related to subprime mortgages.
While it is unclear what steps, if any, the banks and regulators may ultimately take, the talks focused on raising as much as $15 billion for the companies, according to several people briefed on the discussion who asked not to be identified because of the sensitive nature of the discussions.
The notion that the failure of even one big bond insurer might touch off a chain reaction of losses across the financial world has unnerved Wall Street and Washington. It was a factor in the Federal Reserve's decision on Tuesday to calm investors by reducing interest rates by three-quarters of a point, to 3.5 percent.
News of Wednesday's meeting helped rally stocks, which had been down as much as 3 percent but ended up about 2 percent. Shares of MBIA jumped by nearly a third and Ambac jumped 72 percent, although they both remain far below their levels before the extent of the mortgage debacle became known.
Traditionally, bond insurance has been a low-risk business. State and municipal bonds rarely defaulted, so the insurers paid out few claims for such debt. But in recent years the bond insurers increasingly have guaranteed debt related to subprime mortgages, a business that they thought was safe but has turned out to be risky.
Now, as many subprime borrowers are defaulting, insurers could be obligated to cover some of the losses on securities backed by these loans.
Eric R. Dinallo, the New York insurance superintendent who regulates MBIA, called Wall Street executives on Tuesday to set up the meeting at his office in Lower Manhattan. He led the session on Wednesday and suggested that the group move in as little as 48 hours to get a deal done ahead of any downgrading of the bond guarantors by credit ratings firms.
According to two people, Mr. Dinallo said he would talk with the bankers one on one and reconvene the group -- which included executives from Citigroup, Goldman Sachs and Merrill Lynch -- on Thursday or Friday. Neither federal officials nor executives of the two insurers attended the meeting.
Regulators are furiously trying to come up with a plan, said Rob Haines, an analyst at CreditSights, a research firm, who was not at the meeting.
Mr. Dinallo could face resistance from banks that do not have significant exposure to the guarantors and thus have less incentive to put up money. It is also unclear how executives and shareholders of the companies would react to the plan and the prospect of ceding control.
Sean Dilweg, the commissioner of insurance in Wisconsin, which regulates Ambac, sat in on the meeting but said he would be working with Ambac directly. Mr. Dilweg said he met separately on Tuesday with executives at Ambac, which is based in New York but chartered in Wisconsin.
Eric is looking at the overall issue, but I am pretty confident that we will work through Ambac's specific issues, Mr. Dilweg said in a telephone interview. They are a stable and well-capitalized company but they have some choices to make.
Other options open to the banks include providing lines of credit and other backup financing to the guarantors. A chief goal of any rescue would be to help the companies regain or keep triple-A credit ratings, which are seen as vital to their business.
Late last year, Mr. Dinallo encouraged Berkshire Hathaway, the company controlled by Warren E. Buffett, to enter the bond insurance business. At the time, Mr. Buffett said he did not want to invest in existing guarantors because of their financial problems, and he started his own firm instead.
Since then, the troubles have worsened. Last week, Fitch Ratings downgraded Ambac's credit ratings to double-A, from triple-A. MBIA still has a triple-A rating from the three agencies; the others are Standard & Poor's and Moody's Investors Service.
While $15 billion might seem like a large amount of money for banks to commit to bond guarantors at a time when many investors have lost faith in them, Mr. Haines said it would be smaller than the billions the banks might have to write down if the companies lost their top ratings or incurred major losses.
It's a calculated kind of risk, he said.
A spokesman for Ambac did not return calls seeking comment. A spokeswoman for MBIA declined to comment.
Analysts say it is unclear how much money would be needed to capitalize the companies adequately. Ratings agencies have changed their requirements several times already as they update their assumptions of defaults and losses on mortgage securities.
What is needed to do the job is to solidify the market perception of a triple-A rating, said Sean Egan, founder of Egan-Jones Ratings, a firm that says the companies may need to raise as much as $30 billion.
A recent effort by some banks to help a smaller bond insurer, ACA Capital, has not gone smoothly. The banks have twice agreed to give the company, which was downgraded to triple-C from single-A, more time to come up with an acceptable plan.
State regulators are under pressure to help solve a problem that many critics say could have been avoided with closer supervision. The insurers' problems are also spilling over into the municipal bond market, making it harder for cities, counties and states to raise money for projects.
On Wednesday, for instance, some short-term insured municipal bonds, which typically trade at a premium to other bonds, were trading at a discount of as much as 1.5 percentage points to similar uninsured bonds, said Michael S. Downing, an account manager at Thomson Financial.
The companies have defended their assumptions. They also note that losses on the bonds that they insure would have to rise substantially before they would have to pay claims, and even then they would make interest and principal payments over the life of the bond, not all at once.
MBIA has estimated that in the worst case, which it described as a one in 10,000 event, it expects to incur losses of $10 billion, a fraction of the $673 billion it has insured.
Still, losses of that magnitude could strain the company's finances, and the difficulties continue to mount. On Wednesday, Moody's said it was considering downgrading a company, Channel Re, that reinsures more than $40 billion of insurance contracts written by MBIA. If the reinsurer is downgraded, MBIA, which owns more than 17 percent of Channel, would have to acknowledge fresh losses.
If you are a bond insurer or bank you can never really eliminate the risk that you originated in entirety, unless you sell it, said Edward J. Gerbeck, chief executive of Tempus Advisors.
