Posted on 02/15/2008 9:24:55 PM PST by TigerLikesRooster
Regulator in crisis talks to save bond insurers
By Aline van Duyn in New York
Published: February 15 2008 22:00 | Last updated: February 15 2008 22:00
New York’s insurance regulator will hold talks this weekend with sovereign wealth funds, Warren Buffett and other investors in an urgent effort to stabilise credit ratings on $220bn of municipal bonds guaranteed by the Financial Guaranty Insurance Company, the troubled insurer.
FGIC, which lost its triple-A credit rating this week, has asked the New York insurance regulator to allow it to split its municipal bond business from its riskier activities, which involve guaranteeing more complex “structured” securities, some backed by payments from subprime mortgages.
By separating the “good book” of municipal guarantees from the “bad book” of guarantees on structured debt, regulators are hoping to stem a municipal bond crisis that is pushing up funding costs for municipal borrowers across the US.
“In the coming days, we will have discussions about how to deal with capitalising the good book [of FGIC],” said Eric Dinallo, New York’s insurance superintendent, who has been leading efforts to push for the recapitalisation of FGIC and its larger competitors, Ambac and MBIA.
“I have a line outside my door for the good book, which includes Warren Buffett, private equity investors including Wilbur Ross and sovereign wealth funds. The good book may need recapitalisation or a back-stop credit facility to remain triple-A,” he told the Financial Times.
Eliot Spitzer, governor of New York and Mr Dinallo’s boss, said regulators also could push for a split of the businesses at Ambac and MBIA if they do not stave off credit rating downgrades. The business model of bond insurers depends on having a triple-A credit rating.
Any split of FGIC is expected to lead to losses for banks that have bought insurance from the company on mortgage-backed securities and collateralised debt obligations and that used it as a counterparty on derivatives positions.
The size of any bank losses will depend on the credit ratings of the “bad book” at FGIC. A group of banks including Calyon, investment banking arm of Credit Agricole; Citigroup; UBS; Societe Generale; Barclays; and BNP Paribas had been discussing a potential capital injection for FGIC. The group reflects the banks most exposed to the ratings losses.
“The reactions of the banks and other institutions that are counterparties for FGIC’s structured finance guarantees will be crucial in determining whether or not this plan will work,” said Donald Light, senior analyst with Celent, a Boston-based financial research firm. “Some may already see FGIC’s guarantees as worthless and have, or will soon, take the balance sheet hit. Others may fight this move.”
Mr Buffett this week revealed he had offered to take over $800bn of municipal debt guaranteed by Ambac, MBIA and FGIC. His insurance operations at Berkshire Hathaway have triple-A credit ratings. His company also has been licenced in New York to operate as a municipal bond insurer.
As at September 30, FGIC insured $31bn of mortgage-backed securities and $28bn of collateralized debt obligations.
Transcript: Eric Dinallo
Published: February 14 2008 15:39 | Last updated: February 14 2008 15:39
Testimony of the New York State Insurance Department Before the Committee on Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, United States House of Representatives
Regarding: Bond Insurance
February 14, 2008
Eric Dinallo
Superintendent of Insurance
New York
“I would like to thank Chairman Kanjorski, Ranking Member Pryce and the other members of the Capital Markets Subcommittee of the House Financial Services Committee for allowing me to testify today.
“My name is Eric Dinallo and I am New York State Insurance Superintendent.
“You have already heard Governor Spitzer discuss the broader issues around bond insurance. Last week I provided a letter that gave detailed answers to some important questions from you office, which I trust was helpful. Now, I would like to review what the New York State Insurance Department has done and is doing. As the primary regulator of this industry, we have a unique perspective.
“As insurance regulators, it is our responsibility to protect policyholders and ensure a healthy, competitive market for insurance products. In the case of bond insurance, there are two main groups of policyholders. There are the municipal governments who bought insurance for the bonds they issued and by extension the investors who bought those bonds. Then there are the banks and investment banks who bought insurance for the structured securities, including mortgage-backed securities.
“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.
“This is an extraordinarily difficult problem. Every single bond insurer is in a different situation with different strengths and weaknesses. They each have a different group of investors and owners, who have different views. They each must deal with a different set of counterparties; that is banks, broker dealers and investment banks, each of which has a different level of exposure. And there are different potential outside investors with differing types of offers.
“Absent a government bailout, which is not planned, it is up to each of these insurers and their counterparties to come to an agreement. This is difficult for some obvious reasons. There are billions of dollars at stake. And there is no agreement on, and indeed no way to know with certainty, just how big the losses from the subprime market will be.
“That said, we are working hard with all parties to reach agreements.
“This is part of our three-point plan, which, as publicly stated first on January 9th, is:
“First, bring in new capital and capacity. We invited Berkshire Hathaway to open a new bond insurer in New York, licensed it in record time and worked with the NAIC to help the company get licenses in all 50 states. In November the Insurance Department approved a $1.5 billion capital infusion into CIFG. We approved MBIA’s capital raising plan in record time. Just last week MBIA raised $1 billion in an oversubscribed public offering. The company has now added a total of $2.5 billion in capital in the last two months.
“Second, we are seeking a broader solution by working with all parties, the insurers, banks, financial advisors, private equity investors, rating agencies and federal officials. At the moment, that means facilitating efforts to strengthen each individual bond insurer, while also including plans to deal with possibly chronically distressed companies.
“Third, we are working on rewriting the regulations for bond insurance to prevent companies from taking on inappropriate risk in the future, while not discouraging the financial creativity that is essential to maintaining our position as the world financial capital. As part of this effort, we continue to discuss many issues with a wide variety of interested parties, and we have already made significant progress toward new regulations that will govern this industry going forward.
“While we are doing all that we can to protect all policy holders and strengthen the bond insurers, if it becomes clear that is not possible, our first priority will be to protect the municipal bondholders and issuers. We cannot allow the millions of individual Americans who invested in what was a low-risk investment lose money because of subprime excesses. Nor should subprime problems cause taxpayers to unnecessarily pay more to borrow for essential capital projects.
“We have been actively discussing all of the options with the bond insurers and, if necessary, we will consider allowing the bond insurers to split themselves into two companies. One would have the municipal bond policies and any other healthy parts of the business. And there is no reason to believe that this cannot be a healthy business. The other would have the structured finance and problem parts of the business.
“We would ensure that the funds paid by municipal governments would go to support their insurance, and not pay for the problems in structured finance. We believe that this plan could produce enough capital to preserve the ratings of and provide protection for the municipal bonds.
“It was to ensure a safety net for the municipal bonds that over the Martin Luther King Day weekend in January we asked Berkshire Hathaway to price the entire municipal bond portfolio of the three largest bond insurers. Earlier this month, Berkshire sent its proposal to the three companies. I believe that there may be other investors who would be interested in investing in the municipal side of the business.
“In the course of my testimony so far I have made two assumptions I ought to stop and address.
“First, I have been assuming that credit ratings will continue to play an important part in the financial markets. 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. But we cannot forget that they play an essential role, if they are doing their job properly, of providing information that makes markets more efficient. It’s not practical for every investor to fully vet every issuer of every stock and bond. The issue now is how to ensure that rating information is accurate, credible and that conflicts are managed properly.
“Second, the Insurance Department is working to maintain a healthy competitive market in bond insurance because it is our job to make sure there is a market for the insurance that individuals, companies and governments want and need. Now, some muni issuers have decided they no longer need insurance and there are questions about the accuracy of municipal bond ratings.
“Time and the market will determine the how much municipal bond insurance is needed. An AAA rating gives municipal bonds the broadest possible distribution among investors. There is more demand for top-rated AAA securities than supply. Again, it is difficult for investors to fully vet the many small public sector issuers. It is likely that a substantial number of government issuers will want the reduced cost of borrowing that a higher rating produces. Project finance, with its one-time or relatively short-lived issuers, is another area where bond insurance makes sense. We have invited in new companies and will work to make sure bond insurance is available to the government issuers that need it.
“As to the future, we have just begun to study how to improve regulation in this area. Our main focus is on the need for immediate action to limit the damage. However, we can offer some broad comments now, with the understanding that we expect to develop more specific proposals soon.
“The primary goal of insurance regulation with respect to financial oversight is to ensure that the insurer maintains an adequate level of solvency and is able to honour policyholders’ claims. The business model for the financial guaranty insurance companies, however, requires that they hold levels of capital that will allow them to maintain the AAA rating necessary to write new business.
“It has become clear that the loss of the AAA rating essentially cripples the company’s ability to do business as a going concern and puts the insurer in a “run-off’ mode. We now are considering whether the sustainability of the business model should be the regulatory standard going forward. While we of course consider claims paying ability as the benchmark, our goal for the future, for all insurers, is to do higher level risk-based examinations.
“Financial guaranty insurance is a complicated business, which is largely based on modelling and underwriting of complex capital market instruments. Total reliance on the rating agencies is not prudent. Rather an independent analysis by regulators of risk positions by FGIs could be more appropriate. It would also require greater transparency between the bond insurers and their regulator, by which I mean, more information and oversight regarding the nature of the risks being insured.
“Within the current regulatory framework, other steps can be taken to restrict the FGIs’ financial leverage to better protect their solvency, and to restrict activities around products that may be too volatile going forward; for example, guaranties of the CDO squared transactions.
“We welcome any suggestions about how to improve our regulations.
“I welcome your questions.”
Ping!
Buffett ping a ding
This is BS. It is like getting a divorce with one side getting the mercedes and the cash and the other side getting the dodge and the credit card bills.
It would be like GM spinning off Delphi and loading up delphi with all the debts and letting it go bankrupt with zero obligations (this happenned except when delphi went BK, GM was still on the hook).
This saves the municipal governments and screws the banks even though, both parties bought insurance from the same firm.
It is like a hurricane destroying one city while the second city is unscathed, but the insurance company that insured both, simply splits in two with one going bankrupt and paying no claims and the other skating by scot free.
I'm getting the popcorn...
Cheers!
FGIC plan could disadvantage some policy holders: S&P
Fri, Feb 15
NEW YORK (Reuters) - Standard & Poor's on Friday said that a plan by bond insurer Financial Guaranty Insurance Co (FGIC) to split into two companies could disadvantage policy holders from its structured finance business, which includes risky mortgage backed debt.They are saying that in the splits, the favored side will be the CDO's and, naturally, the "unfavored" side would be the monolines. They are also saying that they think we may be seeing "something STUPID Monday PM or Tuesday AM with the monolines" and have said this will create instant lawsuits. I wonder how, in court, banks will justify taking on risks beyond their reserves through their game-playing. In those lawsuits, perhaps rulings will be made under which all banks must comply in the future concerning speculations which place at risk reserves because of these shell games...."We have been told that the newly licensed entity could facilitate the insurance of new public finance business and may also be the recipient of previously insured public finance business from FGIC," S&P said in a statement.
"In our view it is possible that this process may result in the allocation of capital or other corporate resources in such a manner that other classes of policyholders may be disadvantaged," the rating agency said.
Also, just for fyi......as of September 30, FGIC insured $31 billion of mortgage-backed securities and $28 billion of collateralized debt obligations.
If you read the Fed's most recent H.3 reports you would see that the banks are borrowing their reserve capital throught the TAF in exchange for worthless level 3 assets that are marked to myth. The fact that these banks are insolvent cannot be allowed to get out to the public lest it incite a bank run.
MBIA and AMBAC must be allowed to fail because there will be no rescuer who wants to insure their toxic waste.
The munis should immediately migrate to Berkshire et al for their insurance needs.
It is my understanding that the other side consists of the senior Tranches sold with the least risk, ie the high end, quality end batch of morgtages. Even if some of these go bad, the insurer has the right to step in and make the missing payments until the market recovers.
The bad and completely rotten tranches are not included in the insured packages.
The matter will be resolved because the rating agencies have their reputations at stake.
“This is BS. It is like getting a divorce with one side getting the mercedes and the cash and the other side getting the dodge and the credit card bills.”
I don’t disagree that it is probably unfair, however, without doing something they are insolvent. The alternative is to let them go bust. The bottom line is that the “good” business will be able to go elsewhere, and the rest will be left hanging.
...banks are borrowing their reserve capital through the TAF in exchange for worthless level 3 assets that are marked to myth. The fact that these banks are insolvent cannot be allowed to get out to the public lest it incite a bank run.I've read about that, as well. "The sheep must stay asleep." However, when there's an elephant in the room, just how long can they get away with saying it's not there? Its removal will draw attention. In the markets....that will come about when, not if, there are more financial institutions going bankrupt than already have (http://bankimplode.com/) and/or there are bailouts.
MBIA and AMBAC must be allowed to fail because there will be no rescuer who wants to insure their toxic waste.I agree. But I wonder if that will happen....
Have you read the following article?
Ackman criticizes bank bailouts for bond insurers
Hedge-fund Manager offers ways to fix muni-bond woes in testimony
What I thought was interesting, besides the testimony going on yesterday....was that, apparently, while Ackman was testifying, Paul Kanjorsky, the Chairman, received a call from President Bush, which interrupted the hearing....and they didn't restart the hearing until after the markets were closed. Apparently, Kanjorsky is bringing up "transparency" in the hearings. A printed version of the hearing is not yet available (as of this post). (Strange that the president would be interrupting an important hearing, imo.)
....Chairman Kanjorski is especially concerned about the effects of the recent decisions by ratings agencies to downgrade a number of bond insurers on municipal debt markets. States, counties, and localities often rely on bond insurance to lower their borrowing costs for building bridges, repairing roads, fixing schools, and easing budget constraints.“In recent years, many bond insurers moved from their core business expertise of assuring municipal debt and began guaranteeing risky, complex structured finance products backed by subprime mortgages,” added Chairman Kanjorski. “The recent bond insurer ratings downgrades as a result of exposures to this subprime debt, and the possibility of more reductions in the future, could have unfortunate consequences for municipal governments. We must, therefore, take action to protect our cities, towns, and boroughs from experiencing unnecessary costs and project delays.”
The insurance companies were just feeble ways for poorly financed municipalities to issue AAA debt. There was and always has been a slight spread in this debt over stand alone AAA muni debt. I guess everyone felt the same way I did.
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