Bond Insurers Seek Shelter Under TARP

Wall Street Journal
October 30, 2008

WASHINGTON -- Bond insurers are urging the government to reinsure their battered portfolios, the latest push by the industry to seek relief under the Treasury's $700 billion financial rescue.

The move sets up a clash with the banking industry, which wants the funds for any Treasury guarantee program to go toward insuring whole mortgage loans rather than securities.

The U.S. bond insurance industry, which guarantees $2.3 trillion in debt securities, is urging Treasury not to exclude whole loans from the program in favor of a broad range of securities.

"Their goal here is a program that would essentially reinsure their positions so the catastrophic losses they are facing would be eliminated," Karen Petrou of the consultancy Federal Financial Analytics said.

Leading bond insurers Ambac Financial Group and MBIA Inc., reeling from a foray into insuring mortgage-backed securities, are lobbying hard for inclusion under Treasury's program to buy equity stakes in banks. So far they have been unsuccessful.

Another part of the financial rescue package, however, presents a way for the industry to recapitalize with help from the government.

Under the financial rescue legislation, Treasury is required to establish a program to insure rotten assets as a complement to its program to purchase such assets from financial firms.

During negotiations with Congress, Treasury showed initial resistance to the guarantee program, pushed by conservative House Republicans as a less costly and more market-oriented solution to the credit crisis. But Treasury has since warmed to the idea, particularly as it has struggled to structure the more complex purchase program, a person familiar with the matter said.

Insuring assets would be simpler for Treasury than buying them. For example, Treasury would be able to avoid pricing the assets -- a particularly vexing issue for the asset purchase program given the current illiquid market.

The guarantee program would be funded through premiums on participating firms. Treasury has solicited public comments on how to structure the program, asking which assets should be made eligible and which firms should be allowed to participate.

Because bond insurers hold risk tied to mortgage-backed securities but do not own the securities, they stand to benefit more from the guarantee program than the Treasury's asset purchase program.       

Ambac, MBIA, as well as other bond insurers Assured Guaranty Corp. and Syncora Guarantee Inc., provided comments Wednesday to Treasury on the program.

Ambac argued that throwing a government lifeline to bond insurers, which have been buffeted by ratings downgrades and frozen out of the capital markets, would have "an exponentially positive impact" on the economy.

In addition to guaranteeing securities, Ambac argued that Treasury should, in effect, cap the industry's losses. The company said Treasury should institute a program to limit losses above a certain level on portfolios of "entities that buy and hold credit risk."

"By enabling financial guarantee insurers to cap their catastrophic losses, the guarantee program would stabilize bond insurance ratings and help restore credibility to their guarantee in the marketplace," Ambac President and CEO David W. Wallis wrote.

MBIA argued that the program should cover a broad range of assets, including securities backed by auto loans, credit cards, student loans and timeshare loans.

However, it said the program is "best suited" for residential mortgage-backed securities and larger pools of such securities that are sold in pieces to investors. Credit default swaps issued by bond insurers also should be eligible, the company said.

Both Ambac and MBIA argued that guaranteeing whole loans would clog up the program and divert resources from insuring  mortgage-backed securities.     

"The size of the MBS market is such that focusing on the securities alone rather than whole loans should have a significant impact on restoring market liquidity," Mr. Wallis wrote.

MBIA said that other federal efforts, such as the Hope for Homeowners program and FHASecure, were better suited to dealing with whole loans. "We believe that the Treasury and the homeowner is better served by having institutions with troubled whole loans works within the parameters of the previously enacted Hope and FHA programs," the company wrote.

The stance sets up a conflict with the banking industry, which sees the guarantee program as an appealing way to unclog their balance sheets without selling assets to the government.

In comments to Treasury, the American Bankers Association wrote that the idea of insuring loans that can be worked out by a bank has "great merit and can potentially be implemented faster than the asset acquisition program."

The bankers group argued that the guarantee program should focus first on residential and commercial mortgages, though mortgage-backed securities and other instruments could be added later. Otherwise, insuring both types of assets could impede the development of whole loan guarantees, it said.

The bankers group warned Treasury to at least initially avoid insuring complex securities "that have confounded the understanding of experts and for which there may be scant data for proper risk assessments."

It also said Treasury could waste taxpayer money by insuring such securities. "Insuring both whole loans, whole loan portfolios and MBS would create a redundancy, potential for overpayment of insured losses, and a resultant risk of fraud," the group wrote.

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