Bond insurers are virtually never discussed as a pivotal and responsible party in the subprime mortgage meltdown. Companies like Ambac and MBIA this week used a new accounting rule to post deceptive earnings gains after multiple quarters of multi-million dollar loses. The duplicity of the bond insurers in earnings reports and the over-all “asleep at the wheel” subprime insurance they issued deserves an airing out…so here goes.
Wall Street knew they’d need a form of insurance to entice pension funds, foreign banks, and other investors to buy the subprime mortgage backed securities they created called CDOs or collateralized debt obligations. A CDO is a form of bond and therefore the bond insurance companies would need to be recruited to complete Wall Street’s high risk scheme to help make CDO investment look less risky.
Was Wall Street trying to pull a fast one on the bond insurers?
Sure, but that’s to be expected. Bond insurers job is to ferret out the bad bets and only lend their stamp of approval to investments that pass muster.
But before we continue let’s look at bond insurers in general. This is a bond insurers business model…insure investors against loss – both principal and interest. Bond insurers typically make their money from truly low risk state and municipal bond insurance. Rarely do those types of bonds default, so the insurance a company issues to cover any losses to investors rarely needs a claim paid.
However, when Wall Street came calling on subprime CDOs, the bond insurers got blinded by their greed seeing a whole new, much more profitable market. They used their AAA rating to issue insurance on obviously risky financial instruments knowing full well if defaults mounted they’d be on the hook for both principal and interest payments to the investors.
Wall Street could now sell billions in subprime CDOs with the bond insurers on board.
If the bond insurers had simply said, “No, we won’t rubber stamp your crappy subprime mrotgage CDOs ruining our name, our balance sheet, and our AAA rating just so you can fleece investors around the globe.”…there would have been no subprime secondary market.
No subprime secondary market…no subprime mortgage meltdown…no subprime mortgage meltdown…no real estate bust…or so the story goes.
If the bond insurers had done even the least amount of “common sense underwriting” of the risk these subprime CDOs held the country could have avoided the creation of the subprime secondary market and the subsequent destruction of said market taking the economy with it. The bond insurers were our last line of defense…and they went AWOL when we needed them most.
With Ambac and MBIA back in the headlines, I thought you should know these type of companies are back playing games with numbers. This time instead of turning a blind-eye to risks, they are using newly passed accounting rules which magically allow them to show earnings gains (at least on paper) where none existed before.
Whether bond insurers are deceiving subprime mortgage CDO investors or their own stockholders, they seem to have no problem acting immorally. With morally indifferent companies having such a powerful position in our financial markets, a better case for a complete overhaul in regulation can’t be found.
Maybe Congress could spend a little more time focusing on regulating the bond insurers and a little less time passing so many forms of new regulation on mortgage brokers most of them will go out of business trying to comply.
Right…who am I kidding?
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Article Author: Rob K. BlakeRob K. has written 49 articles for us.
Visit Rob K.'s Website: http://themortgageinsider.net
Rob K. Blake, a 15 year veteran of the mortgage industry, is a renowned public speaker, author, and former radio talk show host. His blog, TheMortgageInsider.net, is dedicated to educating mortgage consumers, mortgage providers, and investors about both mortgage and housing markets.
Joshua Dorkin
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@Rob – Reading your post here it is evident that you are unaware of how CDOs are structured and overlooking some very important details to this housing correction. Furthermore plenty of money was made on these loans even with the huge write downs. Alot of the troubles with these loans is that they were made to force consumers to refinance and changes in the market conditions prevented them from doing so.
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