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.
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.
Notable exceptions in the municipal sector include: As publicbonds.org points out, a 1994 BusinessWeek article called MBIA "an almost perfect money machine".
This proved to be a watershed moment for the bond insurance industry, igniting steady growth in demand for many years.
[13] FSA insured the first collateralized debt obligation ("CDO") in 1988, and experienced only minor losses in the asset-backed securities (ABS) sector before the 2008 financial crisis.
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.
The insurers had sold credit default swap (CDS) protection on specific tranches of CDOs.
[19][20][21] This business contributed to the monolines' growth in the early 2000s, with $3.3 trillion insured in 2006,[22] with that contingent liability backed by approximately $47 billion of claims-paying resources.
[23] 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.
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.
[24] 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.
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.
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.
[26] 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.
Continuing the trend of reorganization in 2008, Ambac ceased writing business and in 2010 was split into (i) a "segregated account" (with liability for asset-backed and certain other troubled policies) subject to a rehabilitation overseen by the Wisconsin Office of the Commissioner of Insurance and (ii) a "general account" for municipal bond insurance and certain other non-troubled policies.
The company never filed for bankruptcy and is writing new lines of insurance while it runs off its financial guaranty book.
In June 2017, Standard and Poor's lowered the financial strength ratings of National to A from AA− and lowered the long-term counterparty rating of MBIA Inc. to BBB from A−[34] Subsequent to the downgrade, MBIA announced that National would cease, for the time being, the pursuit of new bond insurance business.
[41] She argued that a monoline's business can be seen as the sale of a triple-A credit rating to a municipal bond issuer.
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.
The following decade saw a number of significant municipal defaults, including the two largest – by Detroit and Puerto Rico.
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.