U.S. Bank Regulators See Moderate Risks from Bond Insurers

February 8, 2008

Turmoil in the bond insurance industry does pose a risk to banks and the broader markets, but the risk to the nation’s largest banks may only be modest, according to letters from federal and state financial regulators to a U.S. House lawmaker.

“Given the adverse effects that problems of financial guarantors can have on financial markets and the economy, we are closely monitoring developments,” Federal Reserve Chairman Ben Bernanke said in a Feb. 4 letter to Rep. Paul Kanjorski, D-Pa.

The Office of the Comptroller of the Currency, which oversees large national banks, said the firms it supervises have both direct and indirect exposure to problems in the bond insurance industry. Still, the regulator said in its letter, the problem should be controllable.

“In general, based on information derived from onsite supervision at our banks, we believe that direct exposures from counterparty risk and direct lending are relatively moderate,” the OCC letter said.

The letters were released Wednesday by Kanjorski’s office. Kanjorski, who chairs the House Financial Services subcommittee with jurisdiction over the insurance industry, wrote to the Federal Reserve, Securities and Exchange Commission and some state insurance regulators last month asking about the risks posed by potentially massive losses by top firms such as MBIA Inc.

In a statement accompanying the letters Wednesday, Kanjorski said his subcommittee will hold a hearing on the bond insurance industry on Feb. 14.

“The comments of financial regulators about the problems affecting the bond insurance industry and the shortcomings of its current regulatory regime have convinced me of the real need to reform the oversight of this important sector of our financial system,” Kanjorski said in a statement.

State regulators, who oversee insurance firms on a state-by-state basis, countered that the current regulatory environment has adequately dealt with the situation.

The news comes as rating agencies have either lowered, or threatened to lower, the coveted triple-A ratings of industry leaders. On Tuesday, Fitch Ratings warned it may downgrade its ratings of MBIA’s bond insurance units as part of an industrywide evaluation.

At issue are the subprime mortgages underlying complex securities insured by bond insurance firms. As defaults on mortgages have continued to climb and the housing industry has faltered, projected losses on collateralized debt obligations backed by the mortgages have likewise increased.

That has sparked fears on Wall Street that the losses could lead to the collapse of firms like Ambac Financial Group Inc. and others. In response, major banks, brokerage firms and government officials have been discussing various proposals for rescuing the firms or helping them raise capital.

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