For Immediate Release: February 26, 2009
Governor David A. Paterson today called on Treasury Secretary Timothy F. Geithner to help restore the municipal bond market in order to protect the ability of local governments to borrow by issuing bonds. Governor Paterson is specifically calling for an infusion of capital from the Treasury Department to help stabilize the bond insurance market in order to reduce borrowing costs for local governments.
The current financial crisis has severely hurt local governments’ ability to borrow, meaning higher costs for taxpayers, fewer government services because more must be spent on debt service, and the delaying of needed infrastructure projects because financing cannot be secured. Many local governments, school districts, hospitals and water and sewer districts either cannot borrow or must pay high interest rates. In a letter sent on Wednesday, Governor Paterson included concrete proposals for Secretary Geithner to make it easier and cheaper for local governments to borrow.
Governor Paterson’s proposal will help assure that municipal bond issuers will be able to access bond insurance, which will help local governments borrow at lower cost and alleviate local property tax burdens. The Governor’s proposals are based on the work New York State has done to rebuild the bond insurance market, which has to date relied on attracting private sector funds.
The full text of the letter appears below.
Dear Mr. Secretary,
I applaud the Obama Administration’s efforts to stabilize the nation’s financial institutions by developing creative public-private solutions for troubled assets, to support hard-working homeowners and aid the housing market, and to stimulate the economy and end the recession.
There is one important market for which the federal government has not yet provided support—the municipal bond market. Continued weakness in that market could undermine the stimulus effort, which includes a substantial amount of funds for infrastructure spending.
State and municipal borrowers, including hospitals, school districts and water and sewer authorities, have had substantial problems issuing bonds, and have had either to pay much higher borrowing costs or delay borrowing. When governments cannot borrow, projects must be delayed and workers idled, which hurts the economy and undercuts stimulus efforts. When governments must pay higher costs to borrow, local taxpayers must either pay more taxes or receive fewer services since more of their tax dollars are going to debt service.
One way to help municipal bond issuers is by reinvigorating the market for affordable bond insurance, which can stabilize or raise the credit rating of their bonds and thus lower borrowing costs. Many local government officials have stated that they simply need bond insurance in order to borrow at all. However, most of the bond insurance companies were severely damaged in the current financial crisis, since they, like many other financial institutions, were heavily exposed to the securities tied to subprime mortgages. While the federal government has invested in banks that hold these securities, there has not been an effort to support the insurers.
New York State, through its Insurance Department, has worked with notable success to stabilize the current bond insurers and bring in new companies, using only private sector capital. In less than 15-months, we have facilitated the addition of $15 billion of new capital, licensed two new insurers, and supervised the reinsurance of the municipal bond portfolios of several troubled insurers.
We have begun talks with the National League of Cities about licensing the first mutual bond insurer. This company would function as a not-for-profit insurer controlled by issuers and would be in a unique position to leverage its intimate knowledge and relationships with state and municipal governments to efficiently manage risk and keep premiums affordable.
Most recently, after a year of study and review, the New York State Insurance Department guided and approved a transaction that will effectively divide the assets and liabilities of the largest of the bond insurers, MBIA Corporation, equitably between two insurance companies. One company will have $10 billion in claims paying resources, investment-grade levels of capital and will cover policies on highly structured and housing-related securities including credit default swaps. The other company will have about $5 billion in resources and will only cover policies on municipal bonds through a creative form of reinsurance. This second company received an initial rating of double-A, but the company hopes to raise enough capital to qualify for a triple-A rating and begin insuring newly issued municipal debt. In addition, the $537 billion of municipal bonds currently insured by MBIA should have their value restored. Since about 60 percent of those bonds are owned by individuals, that should help rebuild their confidence and willingness to invest further.
Thus, we have created a sound basis for rebuilding the bond insurance market, and we will work tirelessly to attract additional private capital to help the municipal bond market recover. We plan to work with MBIA and the League of Cities to help them raise private sector funds to strengthen them and help the municipal market. But the Treasury can make this happen much more quickly.
I ask Treasury to consider measures to aid the market, which could be very cost effective in supporting both the stimulus plan and efforts to reinvigorate the credit markets. One possibility is providing $2 billion to $3 billion in capital for the municipal bond insurance market, which could immediately result in one or more strong triple-A rated insurers, ensuring that municipal bond issuers would be able to come to market under the best possible terms. Since the bond insurers have substantial claims paying ability and since the municipal market has been low risk historically, even in the current weak economy, the risk to the federal government for this investment would be small, while the benefit in terms of lower cost of borrowing for taxpayers could be large and immediate.
Bond insurance also offers a highly efficient means to support the troubled mortgage-related assets of the nation’s financial institutions. As Governor of New York, I am deeply concerned about the future health of the major commercial banks and other financial institutions, many of which are headquartered or have major operations in New York. Those banks are among the major counterparties of the bond insurers who provided credit default swaps to hedge collateralized debt obligations backed by subprime mortgages.
Because the bond insurers were downgraded, the value of these credit default swaps declined and the banks were forced to write down the value of their mortgage-related positions. These are among the troubled assets that have been hurting the banks balance sheets and that the federal government is considering buying into its “aggregator bank.”
A highly efficient alternative to purchasing the securities outright would be back the insurance on the securities. To be clear, this is not bailing out the bond insurers, who would put in all related assets and have to absorb all losses until those assets were gone. Instead, the federal government would strengthen the credit rating on the bonds so that they are no longer a drag on the banks’ balance sheet.
Simply put, there are two alternatives:
One: the leading bond insurers have about $250 billion in insurance on subprime related mortgage backed securities that would presumably be eligible for purchase by the new aggregator bank. If the government bought those securities at, for example, 50 cents on the dollar that would cost $125 billion and the banks would face a $125 billion loss.
Two: Another approach could be to have the leading bond insurers pool into a separate special purpose company those policies backing troubled assets along with the related reserves and a significant capital contribution. That could create an insurance pool covering about $250 billion in mortgaged-backed securities backed by about $25 billion in claims paying resources from the bond insurers. If the federal government lent the pool between $10 billion to $25 billion that should make all of these policies high investment grade. The counterparties would no longer have to write down their value. Since the bond insurers would take the first loss, the federal government’s risk would be reduced. There would be a good chance that the government would get its principal back and earn interest on the loan.
In sum, $250 billion, which is a substantial part of the problem that the $1 trillion aggregator bank is designed to address, could be resolved for from 8 percent to 20 percent of the cost of buying the troubled assets. And the banks would avoid a large loss, substantially strengthening their balance sheets. So even if the federal government lent the maximum of $25 billion, it would have a reasonable chance of being paid back with interest and save itself and the banks $250 billion now.
If you have any questions about these proposals, please feel free to contact my Office or Insurance Superintendent Eric Dinallo, who has already discussed some preliminary ideas with Treasury staff under the prior Administration.
I hope you will find these ideas useful, but we stand ready to support you in any effort to strengthen the municipal bond market and restore the credit markets generally.
Thank you for your time and consideration.
David A. Paterson
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