Monolines given five days to find funds

Monolines given five days to find funds

By Aline Van Duyn in Washington and Michael Mackenzie in New York

Published: February 14 2008 14:54 | Last updated: February 15 2008 00:46

Eliot Spitzer, New York governor, gave bond insurers three to five business days to find fresh capital, or face a potential break-up by state regulators who want to safeguard the municipal bond markets.

Mr Spitzer’s warning came shortly before Moody’s Investors Service highlighted concerns about the bond insurers by withdrawing its triple-A credit rating for privately held Financial Guaranty Insurance Company.

However, the sting of Moody’s downgrade was mitigated by its more positive comments about MBIA and Ambac, the two largest bond insurers, which helped send their shares up 8.4 per cent and 12.4 per cent, respectively, in New York trading.

If the bond insurers lose their triple-A credit rating, the bonds and other instruments they insure also would be downgraded. This could trigger more writedowns for banks and other investors that hold such investments and a sharp rise in borrowing costs for local government entities that issue insured bonds.

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Mr Spitzer told the House financial services sub-committee on capital markets in Washington that he believed the crisis involving the credit insurers needed to be resolved in three to five business days. “We will be forced to act sooner rather than later,” Mr Spitzer said.

He said New York regulators were considering a division of the bond insurers into a “good bank, bad bank” structure. Under such proposals, the insurers’ municipal bond businesses would be separated from their riskier activities, such as guaranteeing complex structured securities.

Mr Spitzer did not say what specific steps could be taken by insurance regulators, who operate at the state rather than federal level. But the state regulators have powers to protect policyholders, as well as banks.

The tough tone was echoed by Eric Dinallo, New York’s insurance superintendent, who was appointed by Mr Spitzer and who has been pushing for bond insurers and the banks most exposed to them to discuss new sources of capital. He said his first priority would be to protect the municipal bondholders and issuers.

Mr Dinallo said the regulator would allow bond insurers to split into two companies. Warren Buffett, the billionaire investor, has already offered to take over the municipal portfolios of Ambac, MBIA and FGIC. One has already rejected the offer. Mr Dinallo said other investors were also interested. “If we do not take effective action, this could be a financial tsunami that causes substantial damage throughout our economy.”

Mr Dinallo said he was considering rewriting the rules for bond insurance to prevent companies taking inappropriate risks.

A break-up of the bond insurer model holds grave implications for financial institutions that face writedowns on insurance and derivatives contracts entered into with bond insurers.