Dinallo Considers Breaking Up Bond Insurers; MBIA Doth Protest

Bloomberg gives some updates du jour on the bond insurer front. As rumored, New York insurance superintendent Eric Dinallo is considering breaking up the monolines into the muni operations versus everything else:

Bond insurers may be split into two pieces to bolster credit ratings and protect municipalities and bondholders, New York’s top insurance regulator plans to tell Congress.

One part would operate the profitable municipal bond insurance business, while the other would handle so-called structured finance products, according to testimony prepared for Eric Dinallo, the New York State insurance superintendent. Dinallo is scheduled to address a U.S. congressional committee today.

“Our first priority will be to protect the municipal bondholders and issuers,” according to Dinallo’s testimony. “We cannot allow the millions of individual Americans who invested in what was a low-risk investment lose money because of subprime excesses. Nor should subprime problems cause taxpayers to unnecessarily pay more to borrow for essential capital projects.”

As we noted in an earlier post today, the priorities have been turned on their head. Before, the reason for a rescue was to prevent carnage on Wall Street. That objective has now been shunted aside as municipalities are hit by the seize-up in the auction rate securities market.

And we’ve pointed out that this is not as good a solution as it appears to be:

This seems to be a misguided application of the “good bank-bad bank” approach used in the saving & loan workouts.

But consider the differences: the dead S&L’s landed in the FDIC’s lap. They had to figure out what to do with them, and they wanted to make a recovery on the payments they made in deposit insurance. So the Resolution Trust Corporation was set up. Note that a big issue was that the Federal government had to continue to fund the S&L’s working capital and also pay to keep some staffing going. That cost was considerable and controversial, and led the RTC to sell assets faster than it would have if it had wanted to maximize value.

The reason for segregating assets was simple: there were two different types of investors who might want to acquire them: banks that hadn’t been too badly damaged were interested in the “good bank” assets; distressed players and wealthy individuals went after the “bad bank” assets. The bad bank assets were going sufficiently on the cheap that even parties that had never dabbled in that sort of deal like Ron Perlman made acquisitions and did very well.

But what does a segregation achieve here? No one but an AAA rated party would make sense as a buyer/reinsurer of the muni portfolio. Buffett already having decided to enter the business on a de novo basis means the only interest another insurer is likely to have is reinsurance. But per the discussion above, this is a huge market inefficiency; the insurance adds no value (but sadly appears to be necessary).

And who would buy the rest? The parties who best understand the CDO/CDS exposures and have reason to do a deal are already at the table. You aren’t going to have new parties appear out of the blue. Private equity investors like TPG and Bain Capital predictably said no thank you, we don’t understand this stuff. I’d be curious to know who might suddenly materialize.

It also isn’t clear if there is any precedent for setting priorities among policyholdiers in this fashion, by industry.

A further complication is that Dinallo does not regulate #2 monoline Ambac; that falls to the state of Wisconsin, and Dinallo’s counterparty there, Sean Dilweg, has been notably silent. And MBIA, the guarantor over which he does have authority, is fighting him tooth and nail. From a separate Bloomberg story on MBIA’s remarks to be made at the same hearings:

MBIA Inc., the world’s biggest bond insurer, said it is equipped to survive the slump in prices of mortgage securities and dismissed suggestions that the industry needs a rescue or stronger federal oversight.

“A bailout of highly credit-worthy companies who, at most, are at risk of losing the very highest ratings available, is misplaced,” MBIA Chief Financial Officer Charles Chaplin said in prepared remarks to be delivered today at a hearing of the House Financial Services subcommittee on capital markets in Washington…

“MBIA is more than adequately capitalized to meet obligations to policyholders,” Chaplin, 51, said in his testimony.

Ambac said in a statement last night that Callen will tell the committee the company’s main challenge is to achieve “ratings stability.”…

MBIA said an industrywide bailout may perpetuate existing problems.

“Similarly, MBIA does not believe there is a need for federal oversight of the industry,” Chaplin said. MBIA “is confident that the rigorous oversight it has always been subject to from state regulators and the rating agencies will continue to be more than adequate going forward.”

This testimony is a remarkable bit of chutzpah. Everyone agrees that a loss of a triple A rating will be extremely damaging to the two big bond insurers, but MBIA maintains otherwise.