As if the insurance industry didn't have a bad enough image problem, the potential fallout should bond insurers lose their Triple-A rating due to boneheaded acceptance of subprime exposures has prompted devastating headlines and a new round of questions about whether carriers are adequately regulated–including calls for Uncle Sam to come to the rescue.

By now everyone knows about how bond insurers, over-eager for growth, stepped outside their comfort zone of backing municipal bonds and other relatively safe risks to leap into a bottomless pit–the securitization of subprime mortgages.

Even though bond insurance only accounts for a tiny portion of overall industry premium, failures of judgment in that sector put all insurers in a terrible light and sent regulators scrambling to battle stations.

Keep in mind the public does not appreciate the distinction between one type of insurer over another. To the average person, insurance is insurance. Thus, the story here is that once more, the insurance industry has let the country down.

In a way, the damage done by bond insurers to the industry's tarnished image might be even worse than what happened with disputes over wind-versus-water claims after Hurricane Katrina. That's because the potential impact is reverberating nationwide throughout the entire economy.

Like a child with matches, [the bond insurers have] gotten burned. We must hope that they did not ignite our economic house, as well, said Rep. Paul Kanjorski, D-Pa., who chaired a hearing in Washington on this matter yesterday.

There is no doubt that reckless underwriting by bond insurers could leave the country in the lurch, if a scheme cannot be executed to reinforce the critical security the carriers provide for state and local government agencies floating debt to fund capital projects.

Since the subprime mortgage crisis exploded–taking banks, investment bankers, bond insurers and the stock market down with it–lawmakers, both state and federal, have been scrambling for a solution.

In the short term, capital is being raised at a frantic pace, new reinsurance backing is being offered by Warren Buffett, and talks are underway to isolate the bond insurers' municipal portfolio from its tainted basket of bad mortgage securities.

Long term, however, Congress has gotten into the act, prodded by those who insist that only federal oversight of the insurance industry can guarantee that no similar financial fiasco repeats itself anytime soon. (To read all about this week's hearing in Congress, click here.)

New York Gov. Eliot Spitzer, no stranger to insurance industry shenanigans, went to Capitol Hill with a strong message to Congress: Stay Out!

The fact that the states need to improve does not lead to the conclusion that federal regulation of insurance is the answer, especially given the performance of other federal regulators on this issue, he testified yesterday before the Capital Markets Subcommittee of the House Financial Services Committee.

I would note that just creating an agency with the power to act does not guarantee it will in fact act,” he added. “Creating a national regulator will not make a difference if those appointed to run it choose not to use those powers effectively.

Gov. Spitzer rubbed it in a bit, testifying that many failures have been caused by the lack of federal regulatory entities to regulateor worse, to block prudent regulation by others.” Indeed, he reminded Congress that one of the benefits of having 50 state regulators is that it is more likely that someone will recognize a problem and act on it.

Gov. Spitzer knows of what he speaks. He has already clashed with the Feds over his push to hold nationally-chartered banks accountable for potential violations of state consumer protection laws. The courts rudely gave him a stiff arm on that attempt, thus he is not eager to surrender any state authority to Washington over insurers anytime soon.

What's next? Will Congress do more than grandstand? That depends, I think, on whether New York and others can find a way out of this mess. There isn't much time.

What do you folks think?

Special Reports /

Bond Insurers Give Industry Another Black Eye

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