Bond Insurance Scam Unravels

Earlier, I wrote about the municipal bond insurance scam, in which financially shaky “insurers” receive a fee for “insuring” the bonds of credit-worthy municipalities that are almost certain never to default. The insurers have been aided and abetted by ratings agencies like Moody’s and Standard & Poor’s, which give municipal bonds a higher credit rating if they have an insurer, no matter how worthless or unnecessary such “insurance” may be. The ratings agencies give the financially shaky “insurers” the highest possible credit rating of AAA, higher than the financially healthy municipalities they “insure.” It’s as silly as expecting Bill Gates to get his company’s bonds insured by a used-car dealer.

Now, ratings agency Standard & Poor’s has belatedly recognized that this scam is becoming too obvious to conceal from the public. After a long delay, it has downgraded the credit rating of one obviously financially imperilled “insurer,” ACA Financial, to junk status (CCC), taking away its AAA rating, which it retained even long after it fell into financial distress.

The ratings agency has also placed three other “insurers” — Ambac Financial Group Inc., MBIA Insurance Corp. and XL Capital Assurance Inc. –and larger than ACA — on a “negative outlook,” which means there is a one-in-three chance ratings will be cut in the next two years. But S&P has yet to take away their “AAA” ratings, which falsely suggest to the public that they have better credit than even the vast majority of municipalities that have never defaulted on any of their debts. As I previously noted, Ambac and MBIA deserve junk status, too. They have no business pretending to “insure” the debts of municipalities that are on much stronger financial footing than they are.

Federal regulations that stand in the way of competition with existing ratings agencies need to be rewritten to enable new entrants into the ratings business.

For an additional perspective on the bond insurance scam, see this non-CEI post, which I critique here.