Federal Regulator Not The Cure For Bond Insurer Problems, Spitzer Says

Gov. Spitzer responded in his testimony that "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."

In his opening statement at the hearing, Rep. Kanjorski said that he convened the hearing because, "like a child with matches, [the bond insurers have] gotten burned. We must hope that they did not ignite our economic house, as well."

He added that bond insurance is a "microscopic segment" of the market, explaining that in 2006, bond insurers collected less than one-third of a percentage point of the total premiums generated by the insurance industry. But "even though it is very small, its importance is much greater" than its size, he said.

Going on to list possible legislative measures, Rep. Kanjorski said, "we could mandate federal insurance supervision in this narrow field," but he did not mention any broader optional federal charter-type legislation.

During questioning following his prepared remarks, Gov. Spitzer said the troubled bond insurers have only four-to-five business days to raise enough capital to keep their crucial "triple-A" credit ratings.

He said that if the added funds don't materialize, the state will force the insurers to split their municipal bond and derivative guaranty businesses–an approach that New York Insurance Commissioner Eric Dinallo explained in his later testimony.

"We will need to move in that direction," Gov. Spitzer said. "It is not our first choice, but time is short." Specifically, he said, "it's time for deals to get done."

In his testimony on the substance of the crisis facing the nation's bond insurers, Mr. Dinallo ruled out a federal bailout of the troubled bond insurers, saying it is "not planned."

But he did say that state regulators are considering allowing bond insurers to split themselves into two parts–the healthy component that insures municipal bonds, and the other that would have the structured finance and problem parts of the business.

This would ensure, Mr. Dinallo testified, "that the funds paid by municipal governments would go to support their insurance, and not pay for the problems in structured finance."

"We believe this plan could produce enough capital to preserve the ratings of, and provide protection for the municipal bonds," the priority for state regulators, he added.

In his testimony, Mr. Dinallo said the department asked Berkshire Hathaway to price the entire municipal bond portfolio of the three largest bond insurers early in January, noting that Berkshire sent its proposal to the companies earlier this month.

Gov. Spitzer, addressing the issue of federal regulation of insurance, said, "I would note that just creating an agency with the power to act does not guarantee it will in fact act." He added that "creating a national regulator will not make a difference if those appointed to run it choose not to use those powers effectively."

"Many failures have been caused by the lack of federal regulatory entities to regulate–or worse, to block–prudent regulation by others," Gov. Spitzer continued.

"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," he said.

"Some people say the federal government should be leading the effort" to probe the bond insurance industry, noted Gov. Spitzer. "But the facts are that insurance is regulated by the states, and most of the bond insurance companies are domiciled in and primarily regulated by New York."

He noted that Ambac, the major company that is not domiciled in New York, "has its actual headquarters around the corner from our [insurance] department's office in Manhattan."

After the hearing, Marc Racicot, president of the American Insurance Association, and a former governor himself (of Montana), issued a statement in which he challenged Gov. Spitzer's comments about a federal insurance regulator.

"While the specific problems confronting the bond insurers may have been unique to that sector, their current situation underscores the need for strong solvency regulation that anticipates, rather than responds to, rapid societal developments that can result in major losses," Mr. Racicot said.

He said an OFC would provide "systemic reforms and would achieve a more active federal role in the regulation of insurance."

It would also recognize how the interdependence of our national and global economies affect the risks insurers assume, and thus the products they provide, Mr. Racicot said.

"Just as investors look to bond insurers in the event of a default on a municipal bond, injured workers, drivers, homeowners and businessowners look to their property-casualty insurers for financial protection," Mr. Racicot said.

The hearing grew more intense after the appearances of Gov. Spitzer and Superintendent Dinallo, when the manager of a New York hedge fund that has been selling the shares of the bond insurers short squared off against a representative of bond insurer MBIA.

(Financial dictionaries define short selling as a technique used to take advantage of an anticipated decline in the price of securities by selling borrowed securities which can later be purchased at a lower price.)

Bill Ackman, founder and manager of Pershing Square Capital Management, criticized Mr. Dinallo's efforts to seek a bailout for bond insurers from banks and brokerage firms that are big counterparties to the bond insurers.

"A more efficient solution would involve the banks taking the extra write-downs and being more transparent about their exposures," Mr. Ackman testified. "These firms could then raise more capital or be bailed out themselves, which would be a better option than the indirect method of propping up ailing bond insurers."

Charles Chaplin, chief financial officer of MBIA, during his testimony urged lawmakers and financial regulators to halt "the unscrupulous and dangerous market manipulation activities of short sellers." He demanded, on behalf of MBIA, that the practice and dissemination of "half-truths and misleading information" be "investigated and curtailed."

"Many failures have been caused by the lack of federal regulatory entities to regulate–or worse, to block–prudent regulation by others."

N.Y. Governor Eliot Spitzer