The Wall Street Journal-20080206-Former Spitzer Aide Drives Bond-Insurer Rescue Talks

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Former Spitzer Aide Drives Bond-Insurer Rescue Talks

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At 11 a.m. on Jan. 23, more than 30 top Wall Street executives gathered for an emergency meeting called by New York Insurance Superintendent Eric Dinallo, who wanted to cobble together a rescue plan for troubled bond insurers.

Mr. Dinallo left no doubt who he thought was responsible for the mortgage meltdown that has caused securities guaranteed by the insurers to fall in value as the housing market weakens. "You people created this mess," he told senior officials of Wall Street's top firms, including Citigroup Inc., Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley. "And the headline on this is going to be: 'How Wall Street Ate Main Street.'"

As investors, banks, securities firms and government officials fret over the fate of bond insurers, trying to avoid a wave of downgrades that could result in billions of dollars in losses, Mr. Dinallo is playing a pivotal role in a Wall Street cliffhanger. His initiative has won praise for prodding financial firms to tackle the problem.

Eight banks and brokerage firms are working on a possible rescue of Ambac Financial Group Inc., one of the nation's biggest bond insurers, which recently lost its top rating from one credit-rating firm and faces a possible downgrade by another. Meanwhile, a separate group of banks led by the investment-banking unit of French bank Credit Agricole SA is in talks to arrange a possible bailout of bond insurer Financial Guaranty Insurance Co., according to people familiar with the matter.

But the no-holds-barred strategy, reminiscent of tactics favored by New York Gov. Eliot Spitzer when Mr. Dinallo worked for him in the New York attorney general's office, also is ruffling feathers on Wall Street. While that hasn't imperiled the rescue efforts, it has further complicated the delicate and difficult talks.

After last month's meeting, some participants who were alarmed by the aggressive tone of Mr. Dinallo's remarks called senior officials at the Treasury Department and the New York Federal Reserve, appealing for them to take a substantial role in any rescue effort. After that, Treasury Undersecretary Robert Steel and Timothy F. Geithner, president and chief executive of the Federal Reserve Bank of New York, encouraged Mr. Dinallo to hire an outside adviser with credibility among the various banks, say people familiar with the discussions.

A day after the meeting, Mr. Dinallo put out a statement cautioning that the situation may take "some time" to resolve. After the meeting, he also hired respected Wall Street firm Perella Weinberg Partners for advice.

Mr. Dinallo declined requests for comment. A spokesman said Mr. Dinallo was considering hiring an adviser before last month's meeting. "He was meeting them [the banks] to work with them to try and solve a problem, and that is what we have been doing since," the spokesman said. "He decided that since he was asking the banks for help, he had to have an open and honest discussion of the risks, so everyone could make informed decisions. His goal was to educate, not threaten. That is his approach to regulation, especially in this case, when he is dealing with the banks as policyholders."

The 44-year-old Mr. Dinallo is the son of a TV producer whose writing credits include episodes of "The Six Million Dollar Man" and "Knight Rider." As an attorney, Mr. Dinallo has long had a reputation for talking tough and taking on Wall Street.

While at the Manhattan district attorney's office, he helped prosecute now-defunct A.R. Baron & Co., a brokerage firm whose top officials pleaded guilty to defrauding investors. Mr. Dinallo went to work for Mr. Spitzer in 1999, and was a bulldog in his boss's crusade against Wall Street brokerage firms for allegedly issuing overly optimistic stock research in an attempt to win more lucrative investment-banking business from big companies.

With Mr. Dinallo's help, Mr. Spitzer became a household name throughout the U.S., parading embarrassing emails at press conferences, and eventually winning a $1.4 billion settlement from 10 big firms, including Citigroup and Morgan Stanley.

After being elected governor, Mr. Spitzer picked Mr. Dinallo last year to run the New York insurance department. That gave Mr. Dinallo huge influence in the continuing woes of bond insurers, because the insurance industry is regulated by the states, and many bond insurers are regulated in New York.

"I could not be happier with the way he's gotten involved in a very thorny situation," Mr. Spitzer said.

Bond insurers guarantee the payment of principal and interest on more than $2 trillion in municipal bonds, mortgage-linked securities and other instruments. Policies sold by the insurers make it cheaper for local governments to issue bonds that fund infrastructure projects. If the bond insurers are downgraded, Wall Street could face an additional $40 billion to $70 billion in losses.

Mr. Dinallo already has shown how determined he can be when trying to resolve a major dispute. A bitter feud over insurance claims related to the destruction of the World Trade Center in the 2001 terrorist attacks had been dragging on without a resolution when he took office last year.

"I don't want to say I lost my temper, but I just said: 'OK, this is it,'" Mr. Dinallo said in an interview last year. He hosted a meeting in a large conference room at the department's offices in Lower Manhattan -- the same room where he met last month with banks to discuss the bond insurers -- telling the firms that the WTC dispute was an embarrassing "black eye" for the industry and the real-estate business. His firm stance paid off, with the insurers ultimately agreeing to a $4.55 billion settlement.

Wrestling over the fate of the bond insurers is a tougher challenge. This time, the potential costs are much higher, and the interests of Wall Street firms diverge widely. But executives who participated in the Jan. 23 meeting say Mr. Dinallo did not appear to have a plan going into it.

Mr. Dinallo told participants that the failure of a bond insurer could pose a systemic risk to the financial markets, according to people familiar with the matter. Some involved disagreed with that assessment, while others believed that if it were so, the Treasury and the New York Fed should be leading the bailout, not Mr. Dinallo.

In his subsequent statement, Mr. Dinallo acknowledged "complicated issues." Perella Weinberg is now working with banks on how to structure possible solutions.

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Carrick Mollenkamp and Karen Richardson contributed to this article.