Benefits
Value to issuers
The economic value of bond insurance to the governmental unit, agency, or other issuer of the insured bonds or other securities is the result of the savings on interest costs, which reflects the difference between yield payable on an insured bond and yield payable on the same bond if it was uninsured—which is generally higher. Borrowing costs are generally reduced for issuers of insured bonds because investors are prepared to accept a lower interest rate in exchange for the credit enhancement provided by the insurance. The interest savings are generally shared between the issuer (as its incentive to use the insurance) and the insurer (as its insurance premium). Since an issuer has the option of selling its securities with or without insurance, it will generally only use insurance when doing so results in overall cost savings. Municipal bond insurance premiums are generally paid up-front as a lump sum; while non-municipal bond insurance premiums are generally paid in periodic installments over time. In July 2008, the Association of Financial Guaranty Insurers ("AGFI"), the trade association of financial guaranty insurers and reinsurers, estimated that, since its inception in 1971, the bond insurance industry had saved municipal bond issuers and their taxpayers $40 billion. A majority of insured securities today are municipal bonds issued by states, local governments and other governmental bodies in the United States and in certain other countries. Bond insurance has also been applied to infrastructure project financing, such as those for public-private partnerships, bonds issued by non-U.S. regulated utilities, and U.S. and non-U.S. asset-backed securities ("ABS"). Financial guaranty insurers withdrew from the residential mortgage-backed securities ("RMBS") market after the 2008 financial crisis.Value to investors
Investors purchasing or holding insured securities benefit from the additional payment source provided by the insurer if the issuer fails to pay principal or interest when due (which reduces the probability of a missed payment to the probability that not only the issuer but also the insurer defaults). The value proposition of bond insurance includes the insurers' credit selection, underwriting, and surveillance of the underlying transactions. Significantly, uninsured transactions are often not monitored by rating agencies following their initial rating issuance. In the event of default of such transactions, bond trustees often fail to take appropriate remedial actions absent direction and indemnity from the bondholders (which is typically not forthcoming). In contrast, bond insurers frequently have the ability to work directly with issuers either to avoid defaults in the first place or to restructure debts on a consensual basis, without the need to obtain agreement from hundreds of individual investors. Litigation to obtain recovery, should it be necessary, is the insurer's responsibility, not the investor's. The insurance may also improve market liquidity for the insured securities. The uninsured bonds of an individual issuer may trade infrequently, while bonds trading in the insurer's name are more likely to be actively traded on a daily basis. Investors in insured bonds are also protected from rating downgrades of issuers, so long as the insurer is more highly rated than the issuer. Following the global financial crisis of 2008, municipal market events have helped to refocus investors and issuers on the benefits that bond insurance provides. A number of well-publicized municipal defaults, bankruptcies and restructurings occurred, which proved that bond insurance remains valuable in the public finance market. For example, holders of insured bonds were kept whole by Assured Guaranty and National Public Finance Guarantee in situations involving Detroit, Michigan; Jefferson County, Alabama; Harrisburg, Pennsylvania; Stockton, California and Puerto Rico. In the secondary market, insured bonds have generally exhibited significant price stability relative to comparable uninsured bonds of distressed issuers. Additionally, investors were spared the burdens of negotiating or litigating to defend their rights. Although the financial crisis caused most bond insurers to cease issuing insurance policies, the insurance has continued to remain available from highly rated providers, including legacy insurers and new industry participants.History: 1970s–2008
Prior to the 2008 financial crisis, bond insurers suffered few material losses. Notable exceptions in the municipal sector include: * a 1984 Ambac loss on its exposure to the Washington Public Power Supply System (WPPSS), which helped establish the value of bond insurance; and * a 1998 MBIA loss on its exposure to Allegheny Health, Education and Research Foundation (AHERF), which declared bankruptcy. As publicbonds.org points out, a 1994 ''BusinessWeek'' article called MBIA "an almost perfect money machine". The ''BusinessWeek'' story noted that, as of that time, MBIA had seen only one loss.Ninety-Five Percent Of Our Profits Are Locked InTimeline
1971 saw the introduction ofFinancial crisis
Events
Bond insurers had guaranteed the performance of residential mortgage-backed securities (RMBS) since the 1980s, but their guaranties of that asset class expanded at an accelerated pace in the 2000s leading up to the 2008 financial crisis. Bond insurers were also exposed to residential mortgage debt through collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs) backed by subprime mortgage debt. The insurers had sold credit default swap (CDS) protection on specific tranches of CDOs. This business contributed to the monolines' growth in the early 2000s, with $3.3 trillion insured in 2006, with that contingent liability backed by approximately $47 billion of claims-paying resources. These exposures were all in compliance with Article 69 of the New York Insurance Law and other states' financial guaranty insurance statutes and with capital adequacy guidelines set by the rating agencies. As the housing bubble grew in the mid-2000s, bond insurers generally increased the collateral protection required for the RMBS they guaranteed. But when the housing market declined, defaults soared to record levels on subprime mortgage loans and new types of adjustable rate mortgage (ARM) loans—interest-only, option-ARM, stated-income, and so-called "no income no asset" (NINA) loans—that had been developed and issued in anticipation of continuing appreciation in housing prices. The subsequent real estate market decline was unprecedented in its severity and geographic distribution across the U.S., and was not anticipated by the bond insurers or the rating agencies that evaluated their creditworthiness. Unlike many other types of insurance, bond insurance generally provides an unconditional and irrevocable guaranty—although the insurers reserve the right to pursue contractual and other available remedies. As a result, the bond insurers faced billions of dollars of claims on insured RMBS, with uncertain prospects for recoveries from the sponsors (creators) of those RMBS. Monoline insurers posted higher reserves for losses as these insured securities appeared headed for default. Following the crisis, the bond insurers became aware that many RMBS they had insured included large percentages of loans that were ineligible for securitization, i.e., they should not have been in the RMBS and were subject to repurchase by the RMBS sponsors. As provided under the insurance contracts, the insurers "put back" to the sponsors such loans, which breached applicable representations and warranties ("R&W") regarding what was in the securitizations, i.e., they demanded the sponsors buy the loans out of the pool, as required under the contracts. Such "putbacks" have remained subject to litigation into the second decade following the financial crisis. One indication of the extent of loan quality misrepresentation was a 2011 settlement between Assured Guaranty and Bank of America, which had purchased mortgage originator Countrywide. Under the terms of the settlement, Bank of America made a $1.1 billion payment to Assured Guaranty and agreed to cover 80% of up to $6.6 billion of Assured Guaranty's future paid losses from breaches of representations and warranties on 21 insured RMBS transactions. Subsequently, in 2013, in the first R&W trial to reach a judgment, Flagstar Bank was required to compensate Assured Guaranty in full for past and future claims. The amounts that Assured Guaranty caused R&W providers to pay or commit to pay through putbacks and settlements plus the amount of future projected losses that Assured Guaranty avoided through negotiated terminations totaled approximately $4.2 billion as of March 31, 2015. While the widespread misrepresentations caused bond insurers to experience considerable losses on insured securities backed by residential mortgage loans (including first lien loans, second lien loans, and home equity lines of credit), the most severe losses were experienced by those that insured CDOs backed by mezzanine RMBS. Although the bond insurers generally insured such CDOs at very high attachment points or collateral levels (with underlying ratings of triple-A), those bond insurers and the rating agencies failed to anticipate the correlation of performance of the underlying securities. Specifically, these bond insurers and rating agencies relied on historical data that did not prove predictive of residential mortgage loan performance following the 2008 crisis, which witnessed the first-ever nationwide decline in housing prices. Notably, AGM and AGC did not insure such CDOs, which has allowed Assured Guaranty to continue writing business throughout the financial crisis and ensuing recession and recovery.Impacts on individual companies; regulatory response
The financial crisis precipitated many changes in the bond insurance industry, including rating agency downgrades, several companies ceasing to write new business, dramatic share value reductions, and consolidation among the insurers. The industry's primary regulators in New York also took action, as did their counterparts in Wisconsin. On November 7, 2007, ACA, the only single-A rated insurer, reported a $1 billion loss, wiping out equity and resulting in negative net worth. On November 19, ACA noted in a 10-Q that if downgraded below single-A-minus, it would have to post collateral to comply with standard insurance agreements, and that—based on current fair values—the firm would be unable to do so. On December 13, 2007, ACA's stock was delisted from the New York Stock Exchange due to low market price and negative net worth, although ACA retained its single-A rating. On December 19, 2007, the company was downgraded to triple-C by Standard & Poor's. Downgrades of major triple-A monolines began in December 2007, resulting in downgrades of thousands of municipal bonds and structured financings insured by the companies. In 2007 Warren Buffett'sCritiques of the business; rating agencies
Some have criticized the whole business model of financial guaranty insurance. In her book ''Confidence Game'', Christine S. Richard examined the industry's basic assumptions. She argued that a monoline's business can be seen as the sale of a triple-A credit rating to a municipal bond issuer. She noted that the rating agencies had different rating scales for municipal issuers and non-municipal issuers (e.g., corporations). Some argued that if the rating agencies had rated municipalities on the same scale they used to rate corporations, the municipalities would have been higher rated, obviating the need for bond insurance. The question was debated before Congress in 2008, at the House Committee on Financial Services under Barney Frank. Richard Blumenthal, then-attorney general of Connecticut, Ajit Jain of Berkshire Hathaway, then-Superintendent Eric Dinallo of the New York State Insurance Department, and a Moody's representative were also in attendance. Standard & Poor's Ratings Services has denied that it employed or employs a separate rating scale for municipal and non-municipal issues. Moody's Investors Service acknowledged that it employed separate rating scales for municipal and non-municipal issues, but has since adopted a uniform rating scale for all issues. The argument that bond insurance provided no value in the municipal bond market was proven wrong not long after the 2008 congressional hearings. The following decade saw a number of significant municipal defaults, including the two largest – by Detroit and Puerto Rico. In both those cases and others, bond insurers kept insured bondholders whole. Richard's book also described the role of hedge fund manager Bill Ackman (Gotham, Pershing Square), who grew increasingly suspicious of the viability of MBIA. Ackman believed the company had insufficient capital and he shorted it by purchasing credit default swaps on MBIA corporate debt. He also released reports to the public, regulators and other corporate executives.{{Cite book, title=Confidence Game: How Hedge Fund Manager Bill Ackman Called Wall Street's Bluff, author=Christine S. Richard, date=29 March 2011, isbn=978-1118010419 Commentators such as investor David Einhorn have criticized rating agencies for being slow to act and for giving the monolines undeserved ratings that allowed them to be paid to "bless" bonds with these ratings.See also
* Credit default swap * Credit Derivatives Product Company * Credit rating agency * '' Nuclear Implosions: The Rise and Fall of the Washington Public Power Supply System''References