MBIA & AMBAC: Bond Insurers Went Astray

Among the casualties this year in the fixed income-related financial sector have been two bond insurers, MBIA & AMBAC. Both have become unstable and caused doubt as to their ability to stand behind their obligations due to mortgage-instrument related losses.


As the nearby Yahoo-sourced, six-month price chart of AMBAC, MBIA, and MGIC versus the S&P500 Index shows, all of these bond insurers have seen their stock prices plummet since July of this year. Why have the three firms suddenly lost so much value?

Mortgage Guaranty Insurance Corporation, MGIC for short, obviously came under pressure for its obligations to payoff on bad mortgage loans and related instruments.

But what about MBIA and AMBAC? I guessed that these firms were not originally in the mortgage-related instrument insurance business. Here's what I found when Googling both firms.


MBIA's history, which reads, in part,

1973
Municipal Bond Insurance Association (MBIA) forms. Managed by MISC, MBIA is formed by four major insurance companies: The Aetna Casualty and Surety Company, St. Paul Fire and Marine Insurance Company, Aetna Insurance Company (then part of Connecticut General and now part of CIGNA), and United States Fire Insurance Company, a Crum & Forster Company.

1971
Municipal Issuers Service Corp. (MISC) forms. It becomes the managing agency of the Municipal Bond Insurance Association, which was created in 1973.


AMBAC's site tells us,

1971
American Municipal Bond Assurance Corporation (Ambac) is founded in Milwaukee, Wisconsin as a subsidiary of MGIC Investment Corp. Ambac begins with $6 million in initial capital and receives a AA rating from Standard & Poor's (S&P). Ambac insures its first issue, a $650,000 general obligation bond for The Greater Juneau Borough (Alaska) Medical Arts Building Company. The issue funds construction of a medical arts building and a sewage treatment facility adjacent to the local hospital.

1974
Ambac's first competitor, Municipal Bond Insurance Association (MBIA), formed as a consortium of four major insurance companies, receives a AAA rating from Standard & Poor's.

As I surmised, both were originally municipal bond insurers. Now, as it turns out, a friend's daughter has the opportunity to interview for a municipal finance-related internship, among other choices, at a large investment bank. In order to help her choose from the options available to her, I gave her a description of what actually occurs in the process of financing a municipality's capital requirements.
Doing so reminded me of a key difference between municipal and mortgage bond insurance. Municipalities have a great degree of authority over the generation of income to pay interest on and, ultimately retire their obligations. True, the occasional situation arises, such as Cleveland, New York City, or Orange County, where mismanagement of the city causes solvency issues.

But mortgage insurance is far riskier. Compared to a municipality's ability to tax and raise fees, a mortgage is typically repaid from the borrower's far more risky and volatile personal income stream.

One has to wonder at the wisdom of AMBAC and MBIA jumping into the mushrooming world of mortgage-backed instrument guarantees. I'd be willing to bet that, compared with the sleepier, slower-growing world of municipal obligations, the burgeoning volumes of CDOs with mortgages underpinning them became too tempting for the two municipal bond insurance firms.

It probably seemed relatively simple to them to hire some experienced mortgage bond analysts, leverage their existing operations into the new sector, and watch the new income invigorate their stock prices.

Instead, both AMBAC and MBIA are ending the year down more than 60%.

It seems that financial excess wasn't limited to just the borrowers and lenders. Even the insurers got into the act. No wonder Warren Buffett has chosen this opportune time to enter the municipal bond insurance business- while the two major competitors are reeling from losses in unrelated market segments.