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New York Post


The Bond Mess: Eliot's Bad Fix

February 21, 2008

By Nicole Gelinas

THE Port Authority and other public borrowers are paying steeply higher interest on some debt because Wall Street screwed up. And Gov. Spitzer and state regulators can make the mess worse.

The problem started because an obscure set of financiers known as bond insurers took a business many deem to be a public trust—insuring municipal bonds like the Port Authority's—and squandered it by also insuring bonds backed by shaky mortgages.

In recent weeks, that has forced municipalities to start paying "penalty" interest rates on some variable-rate debt through little fault of their own.

For decades, a few firms most people never heard of—MBIA, Ambac, FGIC and more—have acted like co-signers for local and state governments and public authorities that want cheap debt to build schools and fix roads.

These municipalities generally have decent credit without the co-signer. But they don't have credit's "gold standard": a triple-A rating. Why not? It's similar to personal credit: Someone with millions in the bank has a better chance of paying his credit card on time, and so can get a better rate than the guy who just holds down a steady job.

And investors in municipal bonds or in muni-bond funds—many of them upper-middle-class retirees—don't want to think about risk at all. They want to know their money is safe. To assure them, public borrowers have gone to the people who have that AAA-rated credit, by virtue of huge capital reserves and sterling reputations: MBIA and the other bond insurers. They pay the insurers upfront so that they can "borrow" the insurers' own AAA ratings.

But this happy system is dissolving into misery—because bond insurers were also insuring the riskiest mortgages, so now have to pay investors in mortgage bonds when the mortgage borrowers don't.

And the ratings agencies that give the bond insurers their AAA ratings (along with investors in the muni bonds themselves) are wondering if the bond insurers can pay all those likely claims.

Even if the insurers have the cash, they may not have enough money (or reputation) left to keep those all-important AAA ratings. FGIC has already lost its rating, and the markets are already behaving as if other muni-bond insurers will lose theirs, too. That's why the PA wound up paying a 20 percent "penalty" interest rate (up from 4 percent) on some bonds.

State and local leaders across the country (and investors in their muni bonds) complain that they're being punished for something that's not their fault. Yes, there's always a risk to issuing bonds whose interest rates "reset" frequently—but one can hardly blame municipalities for not foreseeing this strange situation.

Spitzer and his insurance regulator, Eric Dinallo, think they have a solution. If big banks don't immediately pump billions into the bond insurers to make the market happy (or if the insurers don't capitulate to billionaire Warren Buffett's offer to simply buy out their muni-bond insurance business at a dear price), Spitzer and Dinallo say, they'll use their regulatory powers to let the insurers break up—that is, split their business in two, with "good" muni bonds in one company and "bad" mortgage bonds in the other.

But there are a few problems with that.

First, the state has a conflict of interest. It's a regulator, but also stands to lose money as an issuer of insured muni bonds. New York and its authorities have nearly a fifth of their outstanding debt in about $4 billion of "insured" bonds whose interest rates reset frequently—all of which could face millions in higher rates in even short-term turmoil.

So splitting the bond insurers into "good" and "bad" firms may make investors wonder if the state is thinking of itself, rather than thinking of all insurance clients as a regulator should. And some investors will likely sue.

After all, it's unlikely that the "bad" insurance company would survive after a split. That is, the firm that gets the mortgage bonds won't be able to pay out on its claims. People and institutions that bought subprime mortgages only because they, like muni bonds, came guaranteed with a AAA rating, will lose.

Original Source:



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