14 February 2008

US regulator Dinallo considers rebuilding Bond Insurance market

New York Insurance Superintendent Dinallo considers a split-up of monoline bond insurers to protect policyholders and insure the critical AAA ratings of guarantors Ambac, MBIA and FGIC. “We cannot allow the millions of individual Americans who invested in what was a low-risk investment lose money because of subprime excesses”, Dinallo said in a testimony made before the Committee on financial services. “Nor should subprime problems cause taxpayers to unnecessarily pay more to borrow for essential capital projects.”

Monoline bond insurers guarantee debt on some $2.5 trillion in securities but have fallen on tough times because the esoteric, structured, subprime-tainted securities that they insured in 2006 and the first half of 2007 are souring as the mortgage market collapses.

Rating agencies have been increasingly demanding that financial guarantors raise more capital to protect against losses or face downgrades. Insurers Ambac and FGIC have already been downgraded.

The best way to protect all the policyholders is to preserve the triple-A ratings of some of the bond insurers. So we have been attempting to facilitate additions to the capital strength of the bond insurers, not for their own sake, but to protect first policyholders and second the markets and broader economy.

“I have been assuming that credit ratings will continue to play an important part in the financial markets”, Dinallo notesd. “There has been much criticism of the performance of the rating agencies and it is other’s responsibility to oversee rating agencies and determine what reforms are needed. “

Dinallo’s remarks were backed by Patrick Parkinson, Deputy Director, Division of Research and Statistics of the Federal Reserve who stated that “such downgrades might adversely affect financial stability” by the potential for disruptions to municipal bond markets, potential losses and liquidity pressures on banks and securities firms, and the potential for further erosion of investor confidence in financial markets generally.

“Further downgrades at some guarantors could spark a retreat from the municipal bond market by some retail and institutional investors”, Parkinson warned and was concerned about the potential for losses at banks that have hedged their holdings of super senior tranches of CDOs of ABS with credit protection purchased from the guarantors. “These hedges lose value when the financial condition of the guarantors deteriorates.”

Testimony Dinallo

Testimony Parkinson

© Graham Bishop