How NY State Helped Start Bond Insurance Crisis (ABK)(MBI)(C)

Ambac (ABK) and MBIA (MBI) figured they could improve their earnings by putting money into swaps and derivative instruments. For years they were not allowed to. They had to watch big banks and investment houses turn in better numbers because they had access to the higher risk/reward paper issued by the mad scientists at places like Goldman.

Now, the New York state Insurance Superintendent Eric Dinallo is trying to get big banks to put up $15 billion in lending to bail out the bond insurance operators. It does make some sense. If the institutions lose their ratings the bonds which they cover could drop in value. Banks hold many of those bonds, so that could trigger more write-offs at places like Citigroup (C).

The irony to all of this is that in 1998, NY State gave the green light to bond insurers taking on more risk. According to The Wall Street Journal Financial Security Assurance, a bond insurer, asked that New York insurance regulators allow them to sell credit-default swaps on asset-backed and mortgage securities.

The answer should have been "no". Bond insurance companies have a quasi-public function. They allow states and cities to borrow money more cheaply by insuring the yields on their debt. Infrastructure gets built more cheaply. The ease of bringing in assets allows local taxes to be lower. It has worked that way for decades.

The bond insurers got their wish. They took on more risk. The taxpayer will get the bill.

Douglas A. McIntyre