The Wall Street Journal-20080215-Spitzer Warns Bond Insurers- Governor Says Firms Have 3 to 5 Days To Raise Capital

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Spitzer Warns Bond Insurers; Governor Says Firms Have 3 to 5 Days To Raise Capital

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The clock is running out for bond insurers to save their triple-A credit ratings.

In congressional testimony yesterday, New York Gov. Eliot Spitzer gave a three-to-five-day time frame for the bond insurers to raise much-needed capital or find other ways to resolve their problems.

Mr. Spitzer urged banks, private-equity funds and investors that are working with bond insurers on various rescue and capitalization plans to "act with some increasing rapidity, because time is short," adding that a congressional move to resolve the issue would likely be too slow.

Bond insurers -- relatively obscure companies that insure the principal and interest payments in the event of default -- have emerged as the linchpins of large swaths of the financial makets, ranging from municipal bonds to short-term securities backed by student loans. With investors worried that potential downgrades will lead to massive write-downs in their holdings of securities guaranteed by the insurers, regulators have been trying to rally banks to help rescue the insurers.

But the efforts so far haven't yielded results, as the banks each have different exposures to the bond insurers and differing degrees of interest in seeing them succeed or fail.

Speaking before a House Financial Services subcommittee, Mr. Spitzer effectively threatened that state regulators -- namely, Eric Dinallo, the superintendent of the New York State Insurance Department -- would "have to act" and potentially "strip the municipal businesses" from the bond insurers if they didn't find a solution soon.

FGIC Corp., the third-biggest bond insurer by amount of insured debt outstanding after MBIA Inc. and Ambac Financial Group Inc., has already lost its top-notch triple-A rating from all three major ratings firms, indicating that the banks so far have failed to devise a way to raise enough capital to save its status. Moody's Investors Service cut FGIC's triple-A financial-strength rating by six notches to A3, with a warning that it could be cut to the lowest investment grade level of Baa if FGIC's strategic and capital plans had "an unfavorable outcome."

FGIC is closely held by mortgage-insurer PMI Group Inc., which owns a 42% stake, and private-equity firms Blackstone Group Inc. and Cypress Group, each with 23%.

Most analysts agree that bond insurers will fail over the long term if they don't carry triple-A ratings. That's because municipal insurers will typically only buy insurance from a triple-A guarantor. Well-capitalized rivals -- including billionaire Warren Buffett's Berkshire Hathaway Assurance Corp.; Financial Security Assurance Holdings; and Assured Guaranty Ltd. -- already are taking away market share in the low-risk municipal-bond insurance business.

The forays of FGIC, Ambac and MBIA into the risky business of insuring complex mortgage-related securities have put them on the hook for potentially billions of dollars of claims as the housing market stumbles.

"The evaluation here is about what they are going to do going forward, strategically," Moody's analyst Jack Dorer said in an interview. FGIC would require $9 billion in capital to cover potential losses at "stress-case" levels, according to Moody's. FGIC is about $4 billion short of that, Moody's said. FGIC declined to comment.

Shares of Ambac and MBIA rallied on hope they wouldn't be downgraded by Moody's as the rating agency said in its FGIC statement that they were "better positioned from a capitalization and business franchise perspective." In 4 p.m. composite trading on the New York Stock Exchange, Ambac shares rose 12% to $10.53, while MBIA shares were up 8.4% at $12.62.

Moody's also cut the credit rating of FGIC's senior debt to Ba1 from Aa2, and said that the ratings remained on review for further downgrade to deeper junk.

"These rating actions reflect Moody's assessment of FGIC's meaningfully weakened capitalization," Moody's wrote in a statement.

Moody's said FGIC is pursuing several capital-raising and restructuring plans, which "would not likely eliminate the company's capital shortfall at the triple-A rating level." FGIC insured about $45 billion of municipal bonds in 2007, a little more than 10% of the $425 billion insured last year, according Thomson Financial.

The Moody's downgrade -- which could prompt money-fund managers to unload their FGIC-insured holdings -- is more severe than the downgrades of FGIC to double-A in January by Fitch Ratings and Standard & Poor's.

If the municipal businesses are separated from the bond issuers, as Gov. Spitzer described, the bond insurers would be downgraded and left to manage their existing portfolios of complex debt securities while their lucrative, low-risk municipal businesses would be sold. Mr. Buffett, for example, has offered to reinsure up to $800 billion of the insurers' municipal-bond portfolios, which would protect policyholders but would do little to help the companies.

Mr. Spitzer, who took on Wall Street as attorney general, jostled with Republicans at the hearing and slammed the Bush administration for its oversight of the banking industry. Several lawmakers said Congress should explore whether a federal insurance regulator would be better.

The brunt of Mr. Spitzer's attack was aimed at the panel's ranking Republican, Rep. Spencer Bachus, after the Alabaman raised questions about state regulation of banking and insurance.

"Mr. Bachus, you are involved in a fingerpointing exercise," Mr. Spitzer said, speaking over the lawmaker. Later, Mr. Spitzer did something that almost never happens at hearings: He started aggressively asking Mr. Bachus questions. Typically, only legislators are permitted to ask questions.

During a recess, Mr. Spitzer told reporters that splitting the bond insurers' businesses was a last resort. "The clear preference is a recapitalization of the companies," he said. "Even if the deals don't close, the sort of market comfort that would be needed to stabilize the marketplace could get there pretty quickly. We just have to wait and see what happens."

Mr. Dinallo, who worked for Mr. Spitzer when he served as New York state attorney general, has been trying to corral banks into devising ways to bail out the insurers. Some of the banks' reluctance to participate in his plan may stem from memories of his time with Mr. Spitzer, when he 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.

Turning up the heat yesterday on the banks' discussions, he said in an interview that there are "some mechanisms" in the law that allow regulators to "force [the bond insurers] into what's called 'rehabilitation.'" During his testimony before the panel, he asked Congress for a $10 billion line of credit for the bond insurers, which he said could encourage banks to contribute capital.