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Finger pointing over bond insurer crisis

Congress drills into crisis that has shaken Wall Street. New York governor: 'The problems in this market will affect many average Americans.'

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By David Ellis, CNNMoney.com staff writer

Buffett bail-out
Billionaire investor Warren Buffett offers to prop up troubled bond insurers with $800B in reinsurance.

NEW YORK (CNNMoney.com) -- Congress waded into the bond insurer saga Thursday as lawmakers tried to assign blame and prescribe a remedy for the evolving crisis.

Leading the witness list was New York Gov. Eliot Spitzer, who told lawmakers that the cascading financial woes facing troubled bond insurers "threaten serious problems well beyond" Wall Street.

"The problems in this market will affect many average Americans," Spitzer said. "It will affect the cost of college loans. It will affect museum budgets. It will affect state and local taxes."

Executives from bond insurance firms Ambac (ABK) and MBIA (MBI) also testified before the House Financial Services Committee panel. The hearing was marked by finger-pointing - with the bond insurers themselves, insurance regulators and short-selling investors who bet on the insurers' fates among those targeted for blame.

Meanwhile, Moody's Investors Services announced Thursday that it had downgraded bond insurer FGIC to 'A3' from 'AAA.' Moody's cited the company's weakened capital position and its exposure to the mortgage market.

Moody's, however, made a point of stressing that rivals Ambac and MBIA, which remain under review for possible downgrades, were better positioned than FGIC.

Riding the market

Ambac, MBIA and FGIC in recent years had backed billions of dollars worth of toxic mortgage-backed securities that have lost value. Fearful the bond insurers will face a capital shortfall as a result, rating agencies like Standard & Poor's and Moody's Investor Service have threatened to strip them of their top-notch 'AAA' ratings.

Such downgrades would not only cripple the insurers' municipal and corporate debt insurance business, but would spread across the broader financial landscape. Major U.S. financial institutions, which have already lost billions as a result of the credit crisis, would face further writedowns as a result.

A downgrade would most likely spread to Main Street, as well. Municipalities, which issue bonds to pay for public projects like repairing bridges or building schools, would have to pay more to issue debt. It could also lead to tighter lending standards and could create an additional drag on the already troubled U.S. economy.

Some of the bond insurers, however, have stressed threat they remain well capitalized to not only handle existing claims but sustain their top-notch rating.

MBIA has retained its 'AAA' rating for 34 years and "it expects to remain so now and for the the foreseeable future," MBIA Chief Financial Officer Charles Chaplin told lawmakers.

Just a day earlier, MBIA announced that it had completed the sale of 94.6 million shares of its common stock as part of an effort to raise $1.1 billion to bolster its capital position.

Ambac Chief Executive Michael Callen offered similar reassurances.

"There is no question of solvency," Callen said in a televised interview with CNBC. "This is all based on various people's projections of where the mortgage markets are going to go."

Both Callen and MBIA's Chaplin also fired back at short-sellers, who profit when a company's stock declines. Bill Ackman, a hedge fund manager and perennial bond insurer critic at Pershing Capital Management, was also scheduled to testify Thursday.

'The clock is ticking'

Spitzer took the opportunity to tell lawmakers that "the clock is ticking" on various efforts underway to shore up the industry.

Among those spearheading rescue efforts has been Eric Dinallo, New York's top insurance regulator, who is attempting to organize a private-sector rescue of the troubled industry.

Dinallo told the panel that a government bailout is not planned and that he was working hard to fashion agreement between the parties involved.

Spitzer said if no recapitalization plan is reached, there always remained a "good bank-bad bank" option. Such an option, aimed at protecting the insurers' municipal bond customers, would split the bond insurers into two companies: one focused on their sound municipal bond business, the other on the troubled structured finance portion of their portfolios.

Billionaire investor Warren Buffett proposed such a remedy just two days ago but at a steep premium. Buffett offered to take over the liabilities of the three largest bond insurers - widely believed to be Ambac, MBIA and FGIC - by reinsuring about $800 billion of their tax-exempt or municipal bonds.

So far, none of the companies have accepted the deal.

"While we are happy that there is the offer from Mr. Buffett and that others could step in, we are also hopeful in a result that does not require that sort of division," Spitzer told lawmakers.

Buffett was invited to appear at Thursday's hearing but was unable to attend, according to to the office of Rep. Paul Kanjorski, D-Pa., who chaired the session.

During his opening remarks, Kanjorski offered up the idea of creating a federal bond insurance agency, through which the federal government would guarantee against bond defaults. He likened it to how the Federal Deposit Insurance Corp. protects consumers from bank defaults.

"We need to prevent a similar situation from happening again in the future," said Kanjorski. To top of page

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