Let the Lawsuits Begin — II

Consider this article from the WSJ, Bond Insurer Seeks to Split Itself, Roiling Some Banks.  The banks will fight this.  Here are some quotes:

The move may help regulators protect investors who have municipal bonds insured by the firm. But it could also force banks who are large holders of the other securities to take significant losses. Some banks that have been talking with FGIC in recent weeks to bolster the firm were taken aback by the announcement and could yet try to block it, say Wall Street executives.

and —

The banks learned of the split-up plan Friday by seeing it reported on CNBC, this person said, calling it a “bizarre situation.”

All of the banks have hired legal counsel and are prepared to go to court. The person familiar with the situation said FGIC’s move could result in “instant litigation.” FGIC didn’t respond to queries about the banks’ reaction to Friday’s announcement.

 now, it could lead to:

One plan the parties are discussing involves commuting, or effectively tearing up, the insurance contracts the banks entered into with FGIC, according to another person familiar with the matter. In exchange, FGIC would pay the banks some amount to offset the drop in value of those securities, or give them equity stakes in the new municipal-bond insurance company.

and —

However, if a breakup is endorsed by the New York Department of insurance, that could limit the legal liability.

One other wild card: If FGIC splits into two, it could throw into turmoil potentially billions of dollars of bets that banks, hedge funds and other investors have made on whether FGIC would default on its own debt. If FGIC is split, it isn’t clear how those “credit default swaps” would be valued, since one half of the new company would have a higher risk of default than the other.

 To the extent that the NY Department of Insurance limits the legal liability of PMI, they raise their own liability.  If I were one of the banks, I would sue the State of New York, and quickly, because NY is moving more quickly than they ought to.  There is no NY crisis here, and the politicians and bureaucrats of New York should behave as gentlemen, and not thugs.

Now, one thing I would agree with the NY Department of Insurance on is this: no dividends to the holding companies.  Until things stabilize, retain assets at the operating companies in order to make sure that claims can be paid.  If MBIA and PMI go broke, that is no great loss, except to those that hold equities, or holding company debt.  But if the operating subsidiaries go broke, that is significant to those who will make claims against the companies.