Bond insurers would face increased scrutiny under legislation proposed by Rep. Barney Frank, D-Mass., who added the threat of the federal government taking some of the market away from private carriers.

His announcement came as two bond insurers–Ambac and MBIA–lost their “triple-A” financial strength ratings at Moody's (see related story, below).

A provision in Rep. Frank's bill–HR 6308, the Municipal Bond Fairness Act–calls for the U.S. Treasury to collect data on municipal bond insurers, including their financial soundness, concentration, risk management and underwriting standards.

The data could prompt further congressional action. “It may be, based on that, that we have to do some regulation of those insurers,” Rep. Frank said at a Capitol Hill press conference.

The House Financial Services Committee delayed action on the bill until after the Independence Day holiday recess. Rep. Frank, who chairs the committee, announced the delay at the outset of a markup of several pieces of legislation.

He agreed to the delay, he said, in response to a request from Republican committee members who wished to further examine the bill, and because it had only recently been introduced.

Rep. Frank criticized the unequal treatment given to municipal bonds–and in particular full faith and credit general obligation bonds–by credit rating agencies, and the thrust of the legislation is to ensure that such bonds are rated on equal footing with those issued by corporations.

“We want the standard to be likelihood of default,” he explained, noting several times that such municipal bonds have not had a default since 1970, and are virtually as safe an investment as those from the U.S. Treasury.

Currently, he said, rating agencies are using two different standards for corporate and municipal bonds, holding the latter to an unfairly high standard.

Additionally, he said rating agencies take into account outside factors–such as the state of municipal government–when they should instead focus solely on the likelihood that purchasers of the bonds will be paid off, which he said was a near certainty for full faith and credit general obligation bonds.

“The quality of municipal government,” he said, 'is irrelevant.”

Full faith and credit general obligation bonds are backed by a municipality's taxation authority, Rep. Frank noted, adding that in cases where the municipality has difficulty paying, the state government will step in to cover the bonds.

Other municipal bonds, which are tied directly to a specific funding source (such as tolls for a bridge crossing), have greater risk, but should still be given equal footing with rating agencies, he said.

Despite that level of investment safety, Rep. Frank argued that those municipal bonds are paying an “unreasonably high risk premium” because of their treatment by rating agencies, and because the “monoline” insurers offering coverage for the bonds suffered after expanding into other financial instruments.

While the “monolines” were originally referred to as such because they were involved in just the one line, “it became 'mono' as in mononucleosis,” Rep. Frank said. “They got sick and they infected the bonds.”

Rep. Frank also cautioned that, should these municipal bonds continue to be treated differently than others, he believed the federal government could become more involved. “I think we could go further,” he said, including having the federal government serve as the insurer for full faith and credit general obligation bonds.

In fact, he noted that in his view, the safety of such bonds should make obtaining insurance against their default needless. “Making municipal bond issuers buy default insurance is like making a vampire buy life insurance,” he said.

The bill also needs the approval of the House Ways and Means Committee. Rep. Richard Neal, D-Mass., who chairs a Ways and Means subcommittee, is a co-sponsor and said he would work to keep the bill on track there.

Even if the bill should fail to win passage during this shortened legislative season, Rep. Neal said at the press conference, it served the purpose of starting the conversation on the issue.

“What might not pass this year,” he said, “may well become a priority next year.”

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