Barney Frank Threatens to Kill Muni Bond Insurance Business

No, Barney Frank, head of the House Financial Services Committee, did not say in so many words that he wanted to end the municipal bond insurance business. But that’s the implication of the ultimatum.

He told the rating agencies and the insurers that they have a month to make the standards applied to the ratings of municipalities conform with those of corporations. That would mean upgrades for a whole swathe of municipal issuers.

And why is this a death knell for the monolines (assuming you still believe they have a future)? Remember, they are now pinning their hopes for survival on the muni bond business, despite the entry of Warren Buffett, who with his undisputed AAA rating, will be able to cherry pick the best risks. With this move, the number of municipalities that it make sense to insure will drop precipitously. The remaining credits interested in buying insurance will, unlike the past, be ones where there will be a much greater risk of default (there will be no more unduly-harshly rated credits among the population to make the business virtually risk free and highly lucrative) or simply too small to be willing to pay for two ratings (ie, the insurance is cheaper than the initial rating).

Note that Frank also said the Federal government might also get into the muni bond insurance business on a very limited basis. Is the government the backstop for all borrowing risks, first mortgage debt and now munis?

From Bloomberg:

U.S. Representative Barney Frank gave ratings companies a month to fix “ridiculous” standards that they apply to local government debt, as his House committee opened a hearing today on how the firms evaluate municipal bonds.

“I am going to say to the rating agencies and to the insurers: they have about a month to fix this,” Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, told reporters in Washington yesterday. “We’re going to tell them they have to straighten it out.”

California Treasurer Bill Lockyer and other state officials are calling for Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings to change a system they say costs taxpayers by exaggerating the risk that municipal issuers will default on their debts. Every state except Louisiana would be AAA if measured by the scale used for corporate borrowers, according to research by Moody’s.

“This notion of having a separate standard for the municipals because they would do too well on the other standard is ridiculous,” Frank said.

Moody’s Investors Service plans to allow municipal issuers to request a global scale rating for their tax-exempt bonds starting in May, Laura Levenstein, a managing director at Moody’s said in prepared statements….

Lockyer at the hearing plans to ask Congress to pressure the rating companies to change their system, spokesman Tom Dresslar said. Other witnesses set to testify include Ajit Jain, the chairman of Berkshire Hathaway Assurance Corp., Laura Levenstein, a senior managing director for Moody’s, and New York’s superintendent of insurance, Eric Dinallo.

“The current system makes no sense,” Dresslar said. “Taxpayers wind up paying billions of dollars in higher interest rates and insurance premiums.”

Because ratings are typically lower on the municipal scale, local governments have paid insurance companies to back their bonds with AAA ratings, seeking to reduce borrowers’ costs. With insurers’ ratings under pressure because of losses on mortgage debts, states, cities and hospitals have faced higher interest costs on floating-rate bonds backed by the guarantors as investors shun the debt….

Frank said he plans to pressure bond insurers and rating companies to ease the problems in the municipal bond market, without specifying how.

Frank said the federal government also might consider offering guarantees against default to municipal borrowers for a “very, very small percentage.”

“I guarantee that it will never cost much,” he said. “The insurance business was so profitable because you are insuring an entity where you almost never have to pay out.”

Historic values in the municipal market led Ross to buy $1 billion of bonds last week. He also recently committed $750 million of capital to Assured Guaranty Ltd., parent of one of two bond insurers that continue doing business in the primary market because of their stable AAA ratings.

While large issuers such as the state of California can go without insurance, the guarantees give smaller, more infrequent municipal borrowers access to capital markets, Ross said.

“The average municipal bond issue is $33 million and has no liquidity in the aftermarket,” he said. “Unless there is a guarantee of insurance, no one will buy it because no one has time to analyze $33 million of issuance.”