Bond Accountability Commission 2 Recommendations Page 72
Hidden costs to issuers, such as CMSD, associated with bond insurance have become apparent only in the recent past.81 Some bond insurers asserted that they conducted rigorous due diligence in the transactions they insured. If a transaction truly needed insurance, the general view in the market was that a bond insurer would not insure it, so the insurers were perceived widely as entailing little risk.82 Many bond insurers, almost as a group, stepped out of their traditional, limited municipal securities insurance roles and began insuring billions of dollars of mortgage-
rating downgrades of their securities that occurred solely due to bond insurer downgrades, not through any fault of or loss of credit by the municipal issuers. Large numbers of other issuers incurred even greater costs as interest rates rose sharply on many auction rate and variable rate securities as a result of bond insurers’ rating downgrades. Municipal issuers commonly found it necessary to refinance those securities issues at higher interest rates and to pay substantial additional costs of issuance in the refinancing transactions. 81
See, e.g., Norris, “A Lack of Rigor Costs MBIA” (nytimes.com Nov. 13, 2009), which states— MBIA, the financial insurance company, used to hold itself out as a paragon of hard work and number crunching. ‘Each transaction guaranteed by MBIA needs to pass a rigorous underwriting process proving no losses will arise under the worst probable case scenario,’ the company said in a typical investor presentation just three years ago. It added that its payouts for claims over 32 years came to less than $10,000 per year for every $100 million of insurance it wrote. ‘We expect,’ the company added, ‘to remain at that level or better.’ That expectation was wrong. MBIA’s once pristine AAA-rating has now turned into junk and no one wants to buy insurance from the company. … In [a] suit, filed in state court in New York, MBIA details its underwriting process, which does not sound very rigorous. One Appellate Court described the practices of one insurer in an insured municipal securities issue as an “abject failure to satisfy its due diligence burden.” Financial Security Assurance, Inc. v. Stephens, Inc., et al., 500 F.3 rd 1276, 1290 (11 th Cir. 2007), reversing on rehearing an earlier decision at 450 F.3d 1257 (11 th Cir. 2006).
With such a business model and triple-A ratings, it was widely believed by issuers and investors that the bond insurers’ potential for financial difficulty was extremely remote. That assumed, of course, that the bond insurers conducted appropriate investigations of the risks of transactions they insured (or later, upon which they wrote credit default swaps). If a bond insurer failed (which few considered possible, given the image projected by some insurers and information various insurers provided to issuers and investors), investors could continue, of course, to look to the underlying issuers for payment of the securities.
Published on May 14, 2014