Massachusetts Subpoenas MBIA and Ambac Over Disclosure

A reader pointed us to the fact that the State of Massachusetts has issued subpoenas to MBIA and Ambac regarding bond issued by Massachusetts cities and town that they guaranteed from January 1, 2006 onward. According to CNN, the state is investigating whether the insurers made adequate disclosure of their involvement in mortgage-related instruments. Put more simply, could a reasonably inquisitive mind have figured out the bond insurers might be a wee bit overextended?

It is pretty much certain that the bond insurers did not tell the municipalities about their rapidly growing book of securitization risks. I am no expert, but the issue of liability will probably revolve around whether the insurers had an obligation to reveal more than was presented in their public financials and insurance filings, or similarly, whether any of the municipalities attempted to do due diligence and were given less than complete answers.

Needless to say, if the Massachusetts investigation looks like it will lead to a lawsuit, it represents another set of claims against already weak balance sheets, and will make any rescue operation even more difficult.

From CNN:

Massachusetts’ top securities regulator on Wednesday said he issued subpoenas to a pair of municipal bond insurers, seeking information on how much the firms disclosed to cities and towns about their exposure to mortgage-related investments that have recently plunged in value.

Secretary of State William Galvin sent the subpoenas last week to New York-based Ambac Financial Group Inc. (NYSE:AKT) (NYSE:AKF) (NYSE:AFK) (NYSE:ABK) and Armonk, N.Y.-based MBIA Inc. (NYSE:MBE) (NYSE:MBI) He is seeking lists of public bonds in Massachusetts that the firms agreed to back by insuring repayment, and related documents. He gave the firms until Feb. 1 to turn over the documents….

‘This office wants to know when and if MBIA and Ambac disclosed to bond issuers — the cities, towns, districts and other public authorities — that their financial condition as an insurer was being severely impacted as a result of their involvement with these highly risky securities,’ Galvin said.

Galvin questioned whether Massachusetts cities and towns would have relied on Ambac and MBIA for financial guarantees to ensure bond investors are repaid, had the governments known about the firms’ guarantees of CDOs.

If cities and towns are unable to repay bond investors, insurers repay the principal and interest — a guarantee that comes at a premium price to municipalities if the insurer boasts a strong rating from outside agencies that assess’ financial strength.

‘Cities and towns rely on these companies in order to quickly and cost-effectively raise money for such needs as public safety, buildings and schools,’ Galvin said. ‘The market relies on the insurance provided by these companies to price the bonds and to insure that investors get paid in the event of a default.

‘If the credit quality of these companies comes into question, the impact on cities and towns is enormous, raising costs to municipalities and increasing investors’ risk,’ he said.