A primer on bond insurers’ mess

Kai Ryssdal Jan 24, 2008

A primer on bond insurers’ mess

Kai Ryssdal Jan 24, 2008


KAI RYSSDAL: The past six months have been a crash course in the finer points of Wall Street maneuvering. We’ve all learned more than we care to about mortgage-backed securities and special investment vehicles, and the learning curve hasn’t flattened out yet. New York’s insurance regulator says that on top of all their subprime investments gone bad, investment banks might have to pony up as much as $15 billion to bail out their insurance companies. We’ve called Marilyn Cohen for a bond insurance primer. She’s the president of Envision Capital Management. Welcome to the program.

MARILYN COHEN: Thank you so much.

RYSSDAL: Is this just regular old insurance? I mean that’s all we’re talking about here, right?

COHEN: Not even close.


COHEN: Insurers have been in the business, for years, of insuring boring old municipal bonds, to guarantee the timely interest and principal to the individual investor like you and me, who buys municipal bonds because we’re in high tax brackets, and if the institution, whether it’s a city, state, or water and sewer district defaults, or goes into bankruptcy, then the insurance picks up the interest and principal and flows it through to the investor.

RYSSDAL: And low, now we come to the bond market present day, and we’ve got all these complicated, mortgage-backed bonds that have been out there, and still these insurance companies are obliged to provide coverage?

COHEN: Yes, but they got themselves in big problems, because they decided a couple years ago to step out from just boring old municipal insurance. They started insuring some of these more esoteric types of securities called “collateralized debt obligations,” and they decided, “Hey we can get in that business, make a lot of money, flap our insurance, and voila we’ll take it to the bank.”

RYSSDAL: Let me see if I can lay out a chain of events that might help explain why this is all so nerve-racking for people who follow this stuff. If the mortgages behind these mortgage-backed securities default, as is happening frequently these days . . .

COHEN: As we speak.

RYSSDAL: Then the bonds that they are based on default. Then these mortgage bond insurers have to pay up, and the problem of course here is that the defaults are piling up on defaults, and thus the insurance companies are ever more vulnerable?

COHEN: Yes, and they don’t have the reserves. Obviously that’s why they’re talking, the New York head of insurance is talking about, we’ve got to bail these guys out because the reserves aren’t there.

RYSSDAL: Alright, but where’s that money going to come from? Do I have it right that the banks themselves are going to bail out the insurance companies that are providing them insurance, and it’s going to cost maybe $5 billion, maybe more?

COHEN: Now isn’t that ridiculous, because the banks bailing them out is ludicrous. You know this is the way most cycles end. Somebody has to get bailed out. Everybody sues everybody else, and you know what, the only people that are going to make money are going to be the lawyers, you know sitting off the coast of Costa Rica in their yachts.

RYSSDAL: I wanted to get down in the weeds a little bit here. You know banks and institutions have been trading all these insurance obligations back and forth between them. They call them “credit default swaps.” Isn’t that just sort of another layer of what we’ve had happening with the securitization of all these mortgages, people trading they don’t even know what they’re trading?

COHEN: It is indeed, and people are worried about whether or not the counter parties, either the buyers or the sellers of those insurance swaps, are good for the money. So everybody’s putting a big question mark as who’s the ultimate payer.

RYSSDAL: That’s a little scary, who’s the ultimate payer with a question mark.

COHEN: Well it’s very scary, and you know we in the bond market had been predicting this, and you could see that with all that was happening. The equity market though, all of a sudden woke up and said “My Jove we’ve got a problem.” So it’s a mess. Theres’s no question about it, but we will get over it. We will find solutions as far as raising new capital. We will find solutions as far as bailing out these insurers, even though I think it’s despicable, and everybody will lick their wounds and they’ll be off to the races after the cycle ends.

RYSSDAL: Yeah, but how painful is that going to be?

COHEN: Oooo! Very painful. Lots of losses out there.

RYSSDAL: Marilyn Cohen is the president of Envision Capital Management here in Los ANgeles. Marilyn thanks a lot.

COHEN: My pleasure.

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