Monolines: The Spitzer Debate

Includes: AGO, AMBC, BRK.A, MBI
by: Felix Salmon
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Eliot Spitzer, having fought and won his battle with investment banks when he was New York's attorney general, has now set his sights on the monolines. There are two diametrically opposed ways of looking at what's going on, which is not an uncommon state of affairs when Spitzer starts getting righteous.

The first is the point of view of the companies involved: the monolines, their investors, and individuals who believe that corporate legal entities have rights, even when they're closely regulated. These companies have a range of businesses, some of which are profitable and some of which turn out to have been profoundly misguided. Spitzer is essentially seeking to swoop down and grab the profitable, sustainable bit of the business, leaving the crazy structured-finance bit to wither and die (it likely won't be mourned).

Goverments very rarely eviscerate companies in this manner, except for on anti-trust grounds. Would regulators try to force Apple to spin off its iPod/iTunes franchise? Could they grab American Airlines's lucrative international flights to Nigeria? Don't companies - even insurance companies - have rights, and even consitutional rights?

Not really, says Spitzer - not if they're regulated entities like insurance companies which are critical to the smooth functioning of American government. What the monolines do is in the public interest, and if they fail that's in the public disinterest. The regulator was given wide-ranging powers for a reason, and he would be remiss not to use them in this instance.

More to the point, it's worth considering exactly what is the thing which needs protecting. Monolines are so-called because they have just one line of business: in this case, it's insuring municipal debt. Why the regulators ever allowed them to start insuring structured-finance vehicles is far from clear at this point, but it does seem to have involved little bit of a bit of legal sleight of hand and a lot of lax oversight. If the monolines enter a non-core business which puts their all-important triple-A credit ratings at risk, then the regulator can and should be able to separate that non-core business from their real business, which is insuring municipalities. And if the non-core business then fails, that just shows how silly it was to enter it in the first place.

In the middle is a third view. The main benefit of municipal bonds is that they allow small towns and obscure public agencies to raise debt at low rates of interest. It's true they can't do that these days with an MBIA or FGIC wrap, but Warren Buffett has already announced his own municipal monoline, so the municipalities can simply move their business from the old monolines to the new one, while leaving the old municipal business written by the likes of MBIA to subsidise its old non-municipal business.

There are two problems with this compromise view, if you're Spitzer. Firstly, no one wants to give Warren Buffett a monopoly on municipal bond insurance, and it's hard to see who else is going to compete with him going forwards if the existing monolines fail. And secondly, there's a public interest on the buy side of the municipal bond market as well: munis are almost uniquely in the fixed-income market bought by small retail investors who have no interest in taking credit risk. Their bonds have fallen in value not because the issuers have become less creditworthy, but because the monolines ventured out of their core competency. These millions of individuals deserve protection too.

In the long term, as Jesse Eisinger says, the best-case scenario is to do away with municipal bond insurance altogether, or at least radically scale it back. But right now there's a crisis which needs dealing with; once it's dealt with, then we can try to ensure that it doesn't happen again. It's a bit like the Electoral College: it needs reforming, but not in the middle of Bush v Gore.

Is Spitzer a bully? Yes. But I think in this case his bullying can actually be justified. He's elected to represent the best interests of his consituents, and that's what he's doing. Even if that involves a handful of corporate entities who made bad bets losing money or going bankrupt. As Barry Ritholtz puts it:

Understand that this is not just any business; This is an extremely regulated insurance business that exists solely to facilitate capital raises by States and Municipalities to build State facilities for the public good.
They operate by the good graces of the State. No State approval, no business.
If the larger, more influential States -- NY, California, and especially The Port Authority of NY/NJ -- say, WE NO LONGER TRUST YOU, your recklessness has endangered our ability to raise funds thru bond issues to build schools and hospitals and bridges etc., then it is game over.