GOVERNOR SPITZER TESTIFIES BEFORE CONGRESS REGARDING BOND INSURER CRISIS
Speaks to Contributing Factors, Fiscal Implications and Possible Remedies
Governor Eliot Spitzer today testified before the U.S. Congress regarding New York State's ongoing effort to find solutions to the growing bond insurance crisis that is threatening the stability of the financial markets. The testimony was given to the U.S. House of Representatives' Financial Services Committee's Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.
Governor Spitzer provided testimony about the growing problems in the municipal bond insurance market and how they are affecting New Yorkers and Americans. The Governor offered insight into the contributing factors, how the problem became so severe, the potential implications for the wider economy, and why New York is leading the effort to structure a resolution.
"If we do not take action, this could be a financial tsunami that causes substantial damage throughout our economy," said Governor Spitzer. "The Bush Administration has looked the other way as this crisis moved from the financial markets into the entire American economy. This will affect the cost of college loans. It will affect museum budgets. It will affect state and local taxes. A collapse of bond insurers will adversely affect municipalities, investors and, if unchecked, many average Americans. "
The implications of a weakening bond insurance market are substantial. A destabilized bond insurance market will affect millions of individual investors, who own about two-thirds of the municipal bonds either directly or through mutual funds, worth about $1.6 trillion. Local governments that rely on the municipal bond industry to finance important capital projects are also impacted. Some governments, already facing reduced income due to the slowing economy, will have higher borrowing costs -- shifting funds from schools and police budgets to pay off interest.
One example of the way this crisis has directly impacted New York can be seen in the Port Authority of New York and New Jersey. Traditionally, the Port Authority paid four percent on its auction rate securities. Due to a failed auction earlier this week, caused by lack of potential buyers, it is now paying 20 percent on these securities -- a rate level typically only paid by very risky borrowers, which the Port Authority is not. Despite the solid credit rating of the state of New York, and the risk of default on state-backed bonds being virtually non-existent, entities such as the Port Authority are being forced to pay higher costs due to rating downgrades to municipal bond insurers.
With respect to contributing factors, Governor Spitzer referenced the subprime lending crisis and the failure of mortgage brokers, lenders and appraisers to maintain reasonable standards. Bad lending practices were identified several years ago by state attorneys general and others involved in consumer protection, however, steps to correct those problems were blocked by the Bush Administration. Relevant regulators had an opportunity to act, but did not.
These risky loans widely impacted U.S. financial institutions. Write downs and losses on collateralized mortgage securities related to subprime mortgages total more than $100 billion to date. The general tightening of credit has also meant less money available for companies to borrow so they can expand, as well as less money available for consumers to borrow so they can buy homes, cars, appliances and other goods.
According to Governor Spitzer, federal regulators should have stepped in when investment banks securitized and marketed large volumes of bad debt. The U.S. Securities and Exchange Commission (SEC) could have exercised greater scrutiny and oversight when securitized debt was then given top credit ratings by rating agencies, making them appear to be a safe and nearly risk free investments. Finally, the bond insurers, as they sought to expand their business lines past the traditional municipal bond markets, themselves could have done a more independent and better evaluation of risk and refused to provide insurance, when issuing insurance to these structured securities.
New York is involved in structuring a solution because the majority of the biggest bond insurance companies are domiciled in and primarily regulated by New York. The state has a long history of leadership in dealing with problems with the bond insurance industry And New York's statutes for bond insurance -- Article 69 of the New York State Insurance Law --have become the standard for state insurance departments around the country.
Over the last few months, the state Insurance Department has been working daily with all the stakeholdersthe bond insurers, their major stockholders, the banks and investment banks, financial advisors, private equity investors, and the rating agenciesto find solutions to the current problems.
Eric R. Dinallo, Superintendent of the New York Insurance Department, the agency that regulates several major bond insurers at the center of the crisis, also joined Governor Spitzer in testifying before Congress.
Superintendent Dinallo testified that the loss of triple-A ratings by leading bond insurers would cause additional problems for the municipal bond market and for the nation's major banks and investment banks. Dinallo said the Insurance Department has been actively pursuing all potential options.