Ailing Bond Insurers May Make Markets Queasy

The subprime mortgage crisis has now hit two major bond-insurance firms. Both underwrote risky mortgage-backed securities, resulting in big losses, with an impact that could ricochet through the bond market.

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The subprime mortgage crisis might claim another casualty. Two big bond insurance firms that underwrote some of those risky mortgage-backed securities are struggling with huge losses now. New York state officials are trying to help the parties involved design a bailout. If they fail, the losses could ricochet through the bond market, which generates much of the capital American businesses and cities need to operate.

NPR's Jim Zarroli reports.

JIM ZARROLI: The bond insurance business is one of those little-known but vital corners of the financial world.

Ms. KATHLEEN SHANLEY (Analyst, Gimme Credit): Basically, firms such as MBIA and Ambac have provided a security blanket for investors.

ZARROLI: Analyst Kathleen Shanley of the research firm Gimme Credit says the business runs this way. Let's say some big entity like a major city wants to raise money by issuing a bond. To make the bond more attractive to investors, the city has it insured. That guarantees that the investor gets a return, which means the bond gets a AAA rating, which makes it less expensive for the city to issue.

Bond insurance is a huge business. Two and a half trillion dollars worth of bonds are insured, and until recently it was a very safe business. The firms hardly ever had to pay a claim because they dealt mainly with county and municipal governments that rarely defaulted.

Ms. SHANLEY: And the problem was, that was a low-margin business, and they moved into some of these more exotic securities that have turned out to be more risky than people originally anticipated.

ZARROLI: The bond insurers began writing policies to cover a lot of the new highly structured debt products like mortgage-backed securities. Now that the mortgage business is in such trouble, a lot of these securities are suddenly worth less, and these insurers are unexpectedly having to shell out a lot of money for claims, says analyst Rob Haines of CreditSights.

Mr. ROB HAINES (Analyst, CreditSights): We've seen a huge increase in the expected losses that we're going to see on a lot of these structured products, far in excess of what these companies had modeled and far in excess of the capital that these bond insurers hold.

ZARROLI: Two firms in particular, Ambac and MBIA, have suffered especially big losses. Should they be unable to pay their claims, a lot of the investors that bought the bonds they insured, like pension funds and banks, could suddenly have to absorb the losses themselves. And some of them are already suffering from big subprime headaches.

This week, regulators in New York have been huddling with the firms and the banks to try to find a way out of this quagmire. David Neustadt, a spokesman for the state insurance superintendent, said the problem won't be solved overnight.

Mr. DAVID NEUSTADT (New York State Insurance Superintendent): Clearly, it's important to resolve issues related to the bond insurers as soon as possible. But you must understand that these are very complicated issues. It involves a number of parties, and any effective plan is going to take some time to finalize.

ZARROLI: One idea reportedly under consideration is a $15 billion bail-out package. Neustadt wouldn't comment on that, but analyst Rob Haines said such a package would buy the bond insurers some time.

Mr. HAINES: What the $15 billion would do is it would prop up the companies for the near term or immediate term, and it will allow the companies to continue to write(ph) business over the next three to four years as these losses came in.

ZARROLI: Much of the money to prop up the insurers would have to come from major U.S. banks. Regulators are hoping they'll join in the effort. The alternative is to watch one or more of the bond insurers go under. That would mean even bigger losses for the banks down the road. It would also deal a big blow to the bond business and make it harder for everyone to raise money, at a time when the economy is already slowing.

Jim Zarroli, NPR News, New York.

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