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Congress eyes bond insurers amid housing crisis

By Kevin Drawbaugh
/ Source: Reuters

By Kevin Drawbaugh

WASHINGTON (Reuters) - The widening U.S. housing finance crisis prompted calls in Congress on Thursday for new scrutiny of bond insurers and credit raters, while Senate Democrats offered a rescue plan for troubled homeowners.

As the government scrambled to deal with a credit crunch now spreading beyond its origins in the mortgage market, New York Sen. Charles Schumer called for federal regulation of the $2.4-trillion bond insurance industry.

Major bond insurers such as MBIA Inc and Ambac Financial Group Inc are a source of growing concern on Wall Street as their credit ratings come under pressure due to their involvement with risky mortgage-backed securities.

"I am considering introducing legislation that would regulate them," Schumer said at a Senate Banking Committee hearing focused on the state of the economy and the markets.

In a separate hearing in the House of Representatives, New York Gov. Eliot Spitzer told lawmakers problems must be fixed to avoid a "financial tsunami." New York regulators are working on a plan to help bond insurers.

Also on Thursday, Moody's Investors Service cut its top "AAA" ratings on FGIC Corp's bond insurance arm, citing its weakened capital position. FGIC is owned by a group that includes mortgage insurer PMI Group Inc and private equity.

Fears of wider economic damage resulting from problems in the little-known bond insurance business stem from its role in backing municipal bonds issued by local governments to finance essential public projects such as schools, roads and parks.

For many years, bond insurers specialized solely in standing behind municipal bonds, but they moved increasingly into the mortgage-backed debt business during the housing boom and now many of the securities they insured are in trouble.

EXPOSURE SEEN

A senior SEC official told lawmakers that some large investment banks have "material" exposure to bond insurer risk, but the SEC considers their capital and liquidity sufficient.

The agency is looking closely at bond insurer risk at five large U.S. investment banks under its jurisdiction: Bear Stearns Co Inc , Goldman Sachs Group Inc , Lehman Brothers Holdings Inc , Merrill Lynch & Co Inc and Morgan Stanley .

Schumer said the legislation he may introduce would regulate bond insurers "when they do get involved in other types of activities -- at least have some kind of federal oversight greater than we have now."

Federal Reserve Chairman Ben Bernanke, testifying before the committee, responded cautiously to Schumer's proposal.

"I am not quite sure which additional powers you would have in mind," said the Fed chairman, pointing to a deeper problem of distressed assets underlying the securities that the bond insurers chose to stand behind.

"The best way to address this issue is strengthening the underlying economy," said Bernanke.

In an attempt to do just that, the Fed has slashed interest rates since late last year and Congress has passed an economic stimulus package, which was signed into law on Wednesday.

Senate Democrats offered another package on Thursday, this one more focused on the housing market's problems.

HOUSING PROPOSAL

Under the bill, state and local housing finance agencies could use more money from revenue bonds to help mortgage borrowers; businesses would get a tax break involving past losses; consumer groups would get $200 million in fresh funds to counsel borrowers facing foreclosure; and local governments would get $4 billion in grants to ease foreclosure woes.

Although the housing plan is clearly a Democratic project, Stanford Group Co financial services policy analyst Jaret Seiberg said it is backed by several influential lawmakers and it will be difficult for Republicans not to support it.

"We believe it will be very difficult to stop this legislation," said Seiberg, adding that if the package gets through Congress, the issue will become whether President George W. Bush would veto a bill aimed at helping troubled homeowners.

As the bill was being offered, officials of the Securities and Exchange Commission told lawmakers in the hearings that the agency is considering requiring credit rating agencies to differentiate between corporate bonds and structured finance products, as well as make disclosures on past ratings.

A final report on credit raters is expected by early summer, said SEC Chairman Christopher Cox.

Cox said the SEC is reviewing the accounting treatment of securitized subprime loans, capital adequacy at big investment banks and the "quality of issuer disclosure" by companies involved in structured finance.

The SEC is also keeping a close eye on money market funds, which have been hit by a devaluation in their assets.

Cox said the SEC has more than 36 investigations underway in cases involving the mortgage markets.

Separately, the FBI said on Thursday it had recently opened two more investigations similar to the SEC's, making 16 corporations now being probed as part of the FBI's inquiry into subprime mortgage industry fraud.

(Reporting by Kevin Drawbaugh, Patrick Rucker, Rachelle Younglai, John Poirier, Karey Wutkowski, Donna Smith; Editing by Tim Dobbyn)