MBIA warning fuels fears over bond insurers

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Wall Street banks may have to take several billion dollars of additional charges relating to their mortgage-backed derivatives, because of a gathering crisis in the insurance industry.

Shares in one of the biggest so-called "monoline" insurers, which insure the banks against bond defaults, tumbled yesterday after it revealed that it had some $8bn (4bn) of exposure to the most risky kinds of mortgage deriv-atives raising investor fears that its finances could become unstable.

MBIA said it was well capitalised, but the storm came just a day after a smaller rival, ACA, was effectively put out of business by a credit-rating downgrade. ACA's rating was downgraded to junk status by Standard & Poor's; the company said its clients had agreed not to call on it for payments until 18 January.

Wall Street banks take out insurance when they want to limit the risk of losses on mortgage-backed sec-urities (MBSs) and collateralised debt obligations (CDOs), which are packages of MBSs. Insurers such as MBIA, Ambac and ACA guarantee to pay the interest and the principal on bonds, if there is a default.

However, if the insurer becomes unstable, the insurance could be worthless and the banks may have to take larger losses on the underlying derivatives. The questions over the monoline insurers have complicated the picture for banks that are trying to calculate once-and-for-all write-downs on their ill-starred mortgage investments. Some analysts estimate that Merrill Lynch, for example, which is set to report its results in mid-January, has about $5bn of mortgage assets insured with ACA.

MBIA posted information on its website that revealed it had $8.1bn in exposure to so-called CDO-squared assets: CDOs made up of investments in other CDOs. These are one of the most highly leveraged ways to invest in mortgages and one of the most risky, now that record numbers of Americans have begun defaulting on their home loans.

"This new disclosure completely changes our view of MBIA being a more conservative underwriter relative to Ambac," Morgan Stanley analyst Ken Zerbe told clients yesterday. "We are shocked that management withheld this information for as long as it did.

"We had originally questioned how Moody's and S&P could have taken a more negative view of MBIA than Ambac, given our analysis suggested Ambac had a more risky portfolio. Now we know: MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors."