Regulators may need to take further steps within the next week to address problems in the bond insurance industry to prevent them from posing an economic threat that extends beyond Wall Street, New York Gov. Eliot Spitzer told lawmakers Thursday.
While downplaying the idea of a government bailout of financial guaranty firms, Spitzer said the next step may be to have troubled financial guaranty firms split their operations into two companies. Such a division would divide the municipal bond insurance business from the business of insuring riskier asset-backed securities and other structured finance arrangements.
Spitzer called it a "good bank/bad bank" arrangement, and said it was less preferable than if firms like MBIA Inc. and Ambac Financial Group Inc. can obtain their own infusions of capital from private equity firms or other sources.
"The clear preference is recapitalization of the companies" Spitzer told reporters after his testimony before the U.S. House capital markets subcommittee.
He declined to set a specific deadline before regulators would act, but did offer a range of four to five business days during the hearing. He encouraged any investors to move quickly on any potential deals, "because time is short."
"Speed is important at this point," Spitzer said.
At issue is the turmoil in the bond insurance market. The once staid industry has been shaken by ratings downgrades and massive expected losses at major firms that insured assets backed by subprime mortgages.
Lawmakers offered their own solutions. Rep. Paul Kanjorski, D-Pa., said options include prohibiting bond insurers from guaranteeing complex structured finance products or to require federal regulation.
Rep. Spencer Bachus, R-Ala., said reforms are also needed for credit rating agencies that he called "fundamentally flawed."
"Too late, the credit rating agencies have recognized the added risk of subprime-related guarantees to the thinly capitalized bond insurers," Bachus said.
Spitzer said the role of credit rating agencies is a "critical subject for examination."
Dinallo said it was concern about the safety net for municipal bonds that prompted New York to ask Warren Buffett to price reinsurance of the municipal bond portfolios of the three largest bond insurers.
"Earlier this month, Berkshire sent its proposal to the three companies. I believe that there may be other investors who would be interested in investing in the municipal side of the business," Dinallo said of Buffett's Berkshire Hathaway in his prepared remarks.
In response to questions, Spitzer said he would not "force" the bond insurers to accept offers like that of Berkshire Hathaway. Still, he said the offer by Buffett's company has been good for Wall Street.
"The marketplace appears to have taken that as a positive sign," Spitzer told lawmakers.
Spitzer warned that loss of confidence in the bond insurers and the potential loss of their stellar credit ratings would have ripple effects well beyond Wall Street. He blamed a lack of federal regulation for problems that emerged in making risky home loans to subprime borrowers and said New York regulators are studying how best to improve regulation going forward.