- The Washington Times - Friday, February 1, 2008

Worries about the fate of Wall Street’s bond insurers continued to play havoc with the markets yesterday, as stocks staged a major rally on assertions that the biggest insurer will retain its gold-plated credit rating only to have those assurances dashed after the markets closed.

MBIA Inc., reporting an unprecedented $2.3 billion loss on the subprime securities that it insures, early in the day insisted that it will have enough cash on hand to pay defaulted loans because it expects to receive cash infusions from investors. That statement revived slumping stock markets and lifted the Dow Jones Industrial Average to a 208-point gain.

But Standard & Poor’s Corp. later contradicted the company and said it still might cut the company’s AAA rating because of mounting credit losses. S&P; also slashed the AAA ratings of Financial Guaranty Insurance Co., the fourth-largest insurer, after a similar action by Fitch on Wednesday.

The shaky future for the bond insurers, which cannot continue in business without AAA ratings, has provoked much angst on Wall Street. The downgrades threaten to trigger a second wave of losses on mortgage securities that could dwarf the roughly $100 billion of losses already reported by banks and securities firms.

The insurers guarantee nearly $2.5 trillion of municipal bonds and mortgage-backed securities, much of it issued by small cities and state governments with low ratings that otherwise might not be able to raise cash to finance schools, hospitals and other community projects. A downgrade of the bond insurers automatically lowers the ratings on the municipal bonds they insure and reduces their value for investors.

The much-dreaded downgrades threaten the holdings of small pensioners and gigantic institutional investors alike, as the insured securities can be found in nearly every diversified portfolio.

Some mutual funds and pension funds would be forced to divest large portions of their holdings if they lose AAA status.

“The recent-bond insurer downgrades and the possibility of more on the horizon have the potential to affect all aspects of the financial marketplace,” said Rep. Paul E. Kanjorski, chairman of the House Financial Services capital markets subcommittee. The Pennsylvania Democrat has said he will schedule hearings on the “ricochet effects on municipal governments.”

Financial analysts say the losses among bond insurers from defaults on subprime mortgage securities could go as high as $65 billion, triggering wider losses among banks and investors of as much as $145 billion.

The threat of huge losses in recent weeks prompted efforts by New York’s insurance superintendent, Eric R. Dinallo, to organize a $15 billion fund to bolster insurers’ capital. Although the effort has received tacit backing from the U.S. Treasury and Federal Reserve, analysts question whether the funds will be available in time to prevent damaging downgrades.

The insurance companies themselves have had mixed success in attracting cash from investors. Three of those downgraded by Fitch — Security Capital Assurance Ltd., Financial Guaranty Insurance Co. and ACA Capital Holdings Inc. — had been seeking capital since November, to little avail. In addition, billionaire investor Warren Buffett is starting a bond insurance company that will pose major new competition to the faltering insurers.

The bond insurers started out decades ago with the traditional but profitable business of insuring state and local bonds to finance roads and schools. What got them into financial trouble was their more recent venture into the unrelated business of structured finance.

The insurers entered into complex and risky arrangements backing subprime mortgages that were pooled and packaged as collateralized debt obligations (CDO). These CDOs typically are sliced into pieces, or tiers, with most of the riskier investments held by the bottom tiers. It is those lower-rated tiers that got enhanced with insurance to make them more marketable to investors.

“We’re paying for those mistakes,” MBIA chief executive Gary Dunton said in a conference call yesterday. But he insisted that fears of losses from subprime defaults have been grossly exaggerated by the markets.

“The market has overreacted to the real and obvious problems that we’ve had, as well as to the fear-mongering and intentional distortions of facts about our business that have been pumped into the market,” he said. Some hedge funds have circulated rumors about huge losses even as they placed bets on big drops in the insurers’ stocks.

In reporting an $18.61-per-share loss yesterday, MBIA also wrote down the value of its credit portfolio by $3.5 billion and took a $713.5 million pretax loss on its exposure to rising delinquencies and defaults on securitized home-equity loans.

The beleaguered insurer also reduced the value of its 17.4 percent stake in a reinsurance company, Channel Re, to zero from $85.7 million.

Mr. Dunton insisted that it had received assurances from S&P; that its AAA rating was secure as long as it succeeded in raising more than $2 billion in capital. MBIA has already raised $1.5 billion in part through a direct investment by private equity firm Warburg Pincus, but has not completed the fundraising.

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