Dinallo Tells Congress Of New Rules For Bond Insurers

New regulations governing bond insurers that the New York Insurance Department is drafting will mandate greater transparency into the risks the sector is guaranteeing, New York Insurance Superintendent Eric Dinallo told Congress today.

For example, Mr. Dinallo said state regulators are considering whether bond insurers should be prohibited from instruments called collateralized debt obligation.

Superintendent Dinallo's comments were made at a hearing convened by the House Financial Services Committee to look into the volatility and soaring interest costs currently affecting the municipal bond market.

Anticipating calls by members of Congress for dual, federal regulation of the industry, Mr. Dinallo defended state oversight of the bond insurance industry.

"It is important to understand that even restoring some confidence in the bond insurers' credit ratings is not likely to resolve all the current problems," Mr. Dinallo said.

Rep. Spencer Bachus, R-Ala., ranking minority member of the committee, said in an opening statement at the proceedings that bipartisan support is growing on the committee for a disclosure proposal outlined last year by Securities and Exchange Commission Chairman Chris Cox.

That proposal would require meaningful public disclosures "that are current and understandable, with a full accounting of all material information at the time of a new municipal bond issuance," Rep. Bachus said.

Rep. Bachus said that Rep. Barney Frank, D-Mass., chairman of the panel, "has agreed to invite Chairman Cox to appear before the committee later this year to formally consider his proposal."

His comment added substance to Rep. Frank's opening statement, in which he said municipalities are having to pay extremely high prices to float tax-exempt debt--a problem he said was caused by "grievous misjudgments by the private sector" in securitizing risky debt, much of it backed by subprime loans to borrowers who are defaulting.

"I am going to say to the rating agencies and to the insurers [that] they have about a month to fix this,'' Rep. Frank said in comments before the meeting.

He also said that because of the low default rate on municipal securities compared with private-sector debt, it may be unnecessary for municipal issuers to get bond insurance on their debt.

California Treasurer Bill Lockyer criticized rating agencies for the way they deal with municipal debt. Responding to Rep. Frank's notion that municipal bonds might not need coverage, he cautioned that insurance might be necessary because municipalities in offering documents for debt many times understate their financial condition and their obligations--for example, pension liabilities.

He also cited the case of Orange County, Calif., which became insolvent while seeking to keep taxes low and services high by purchasing risky derivatives.

When the derivatives turned sour, the county found itself facing huge obligations.

Mr. Lockyer's comments effectively supported Mr. Dinallo, by saying the answer to the crisis is greater transparency in offering statements for municipal debt.

Mr. Lockyer called the bond rating system for municipal securities "fundamentally flawed" because they hold municipal issuers to a higher standard than corporate issuers.

Mr. Dinallo in describing the rules the department is drafting, said, "There is nothing inherently wrong with securitization."

"Properly used, it can be a valuable tool for raising capital and spreading and therefore reducing risk," he added. "But we must understand the risk of moral hazard and other agency problems when there are large-scale transfers of risk."

Clearly, he said, "there must be a way to ensure that the risks that are securitized are accurately reported through each stage of the process so that underwriters, credit rating agencies, bond insurers and investors all understand the actual risk and make decisions on that basis."