MBIA - another one too big to fail

Bond insurers were front and center in the credit crisis that started in August of last year. In the meantime credit markets have calmed down but today's NYT article by Gretchen Morgenson and Vikas Bajaj reminds us of how frighteningly shaky the financial industry still is. MBIA is in a fight with Eric Dinallo, the commissioner of the New York State insurance department, to recapitalize its muni bond insurance unit with $900 million in cash. While this request/demand is noble MBIA's resistance towards it reveals how desperate the situation for regulators (and eventually for investors) has become.

Besides its muni business the company has guaranteed many other contracts like subprime mortgages and even the financial health of businesses. MBIA has written $137 billion dollar in credit default swaps which insure buyers of such contracts against financial default. In addition buyers get preferential treatment and can demand immediate payment in case MBIA gets into financial trouble (e.g., downgrade by rating agencies).

Eric Dinallo finds himslef in a tight spot, and with him investors in muni bonds and other financial assets, because of MBIA's $137 billion in credit default swaps, which catapults the company into the ranks of BSC and others that are too big to fail.

Mr. Dinallo confirmed last week that the swaps written by MBIA and other financial guarantors were a big factor in his dealings with the weakened bond insurers.

“It is a concern that possibly if one of the companies filed for rehabilitation or if we move to rehabilitate, the holders of the credit default swaps could move to get preferential treatment,” he said.

Mr. Dinallo said he could refuse to honor acceleration demands if he took over a bond insurance firm, but such a move would almost certainly prompt investors who hold the credit default swaps to press their cases in court. The acceleration clause is a standard feature in credit default swaps written by many bond guarantors, including Ambac and the Financial Guaranty Insurance Company.
read on for the full NYT article


source: MBIA Debt Is Setting Up a Quandary
NYT
http://www.nytimes.com/2008/06/18/business/18bond.html