Testifying before the US House of Representatives Financial Services Committee, New York Insurance Department superintendent Eric Dinallo revealed that severing the unaffected segments of monoline insurers’ books from the subprime-exposed structured finance portions has been one of the options under discussion.
"We have been actively discussing all of the options with the bond insurers and, if necessary, we will consider allowing the bond insurers to split themselves into two companies. One would have the municipal bond policies and any other healthy parts of the business. The other would have the structured finance and problem parts of the business," said Dinallo.
"We would ensure 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," he added.
In a hearing characterised by attempts to ascribe blame for the problems suffered by municipal bond insurers, senior executives from Ambac and MBIA surprised congressmen by insisting that many of the solutions being considered, including a regulator-led financial rescue, are misguided and unhelpful.
"The notion of a bailout of highly creditworthy companies who, at most, are at risk of losing the very highest ratings available, is misplaced. MBIA is more than adequately capitalised to meet obligations to policyholders,” said the firm's chief financial officer, Charles Chaplin.
Instead, Chaplin urged regulators to "investigate and curtail... the unscrupulous and dangerous market-manipulation activities of short sellers,” such as hedge fund Pershing Square Capital, which has openly admitted holding short positions against both MBIA and Ambac and recently issued an estimation that MBIA faces losses of $11 billion, a valuation the bond insurer insists is flawed.
"[Pershing Square] would like to see MBIA become insolvent, which would maximise its profits by driving the stock price to near zero and triggering payments on the credit default swaps it executed,” Chaplin insisted.
Pershing Square founder William Ackman wrote to US Treasury secretary Hank Paulson last week warning that bailing out the monolines would "prolong the term and severity of the recent credit contraction," foreshadowing Chaplin's testimony.
Earlier in the hearing, New York governor Eliot Spitzer had taken aim at federal regulators and the White House for frustrating states' efforts to nip the wider subprime crisis in the bud.
"Efforts by states to protect consumers and capital markets were blocked by the Bush administration and, remarkably, the Office of the Comptroller of the Currency acted to preempt state efforts to halt predatory practices but did little to address these serious problems. The OCC was more than happy to allow the problem to grow and the bubble to inflate," Spitzer said.
He went on to blast proposals to establish a federal insurance regulator, saying the failure of existing regulators to forestall the subprime debacle was no reason to assume a new national body would prevent future crises. "Just creating an agency with the power to act does not guarantee it will in fact act. 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," he added.