Oakland Files Lawsuit Against Muni Bond Insurers

July 28, 2008

Oakland, Calif.’s city attorney said Friday he will file a lawsuit claiming municipal bond insurers duped the city into buying bond insurance despite risks the guarantors faced to their triple-A ratings from insuring subprime mortgage-related securities.

Oakland will file its lawsuit against the insurers, including Ambac Financial Group Inc. and MBIA Inc. in August, Oakland City Attorney John Russo told Reuters in a telephone interview.

Ambac spokeswoman Vandana Sharma said the company does not comment of pending litigation. MBIA spokesman Kevin Brown also said the company does not comment on matters involving litigation.

Russo said the lawsuit will be similar to one filed on Wednesday by the city of Los Angeles against several municipal bond insurers.

That lawsuit claimed the insurers reaped illegal profits in a conspiracy to prop up the market for municipal bond insurance while concealing risks to municipalities from the guarantors’ exposure to subprime mortgage-related securities.

“These companies concealed their incredibly weak financial position,” Russo said. “Insurance companies are supposed to be of a certain financial strength and in this case they’re not.”

Most bond insurers lost their top “AAA” ratings, which usually results in lower borrowing costs, as a result of exposure to risky subprime mortgage-related securities.

That left Oakland, its general obligation debt rated “A+” by Fitch Ratings, facing higher costs, Russo said.

“It just doesn’t make sense to have (bond) insurers with a low rating,” he said. “It defeats the purpose.”

Premiums for Nothing
Los Angeles and Oakland are being represented by the law firm of attorney Joe Cotchett, who won a jury verdict for more than $3 billion in a class-action suit against Charles Keating Jr. and associates arising from the savings and loan crisis of the 1980s and 1990s, and the law firm of Louise Renne, a former city attorney for San Francisco.

In his city’s complaint, Los Angeles City Attorney Rocky Delgadillo claimed a conspiracy to prop up the market for bond insurance, adding that Los Angeles was forced to buy insurance from a triple-A-rated guarantor to benefit from that top rating.

Los Angeles has an investment-grade “Aa2” general obligation rating with Moody’s Investors Service and and “AA” rating with Fitch.

Delgadillo did not list Standard & Poor’s, Moody’s and Fitch as defendants, but his complaint noted the rating agencies have “interlocking business relationships” with bond insurers that help underpin the bond insurance market.

Municipalities have proven “far less likely to default than the insurance companies that they paid to guarantee their debt,” the complaint added. “In short, plaintiff paid insurance premiums for nothing.”

Delgadillo told Reuters by telephone his lawsuit and Russo’s looming lawsuit may help bolster California Treasurer Bill Lockyer’s campaign to have municipal debt rated on the same scale used for corporate bonds, which would likely result in a drop in demand for municipal bond insurance amid mass upgrades for municipal debt.

“If there is no risk why should you buy the premium? Or if the risk is minuscule then the premiums shouldn’t be gigantic,” Delgadillo said.

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