Saving the bond insurers: 5 fixes for the crisis

Just about everyone seems to have an idea on how to fix the troubled bond insurers and stave off a crisis that threatens to send the financial services sector into disarray.

Divide and survive
The plan: When testifying before Congress last week, New York Gov. Eliot Sptizer and State Insurance Superintendent Eric Dinallo told lawmakers that the best solution would be to recapitalize the bond insurers. If that failed, they would break up these firms into a "good bank" that would manage their healthy municipal bond insurance business, and a "bad bank" to oversee the smaller structured finance arm. Each division would remain part of a holding company.

The prospects: Likely. Of all the different solutions being floated, this proposal has garnered the most interest. After the bond insurer FGIC was downgraded last week by Moody's, the company asked Dinallo's office for permission to break itself up. Its larger rivals Ambac and MBIA are also reportedly considering similar moves.

A break-up would prevent cities and towns - which buy insurance on bonds they sell to raise money for projects like roads, schools and bridges - from getting saddled with higher borrowing costs. But it is widely believed that, after a split, the structured finance arm would wither and die, meaning downgrades on the asset-backed securities issued by Wall Street and more writedowns.

Uncle Warren to the rescue
The plan: A little over a week ago, Warren Buffett proposed a bold solution for the bond insurance crisis by offering to take over $800 billion of the industry's municipal bond obligations.

Under his plan, companies like Ambac and MBIA would focus on their troubled structured finance arm, which are the source of the industry's woes.

The prospects: Slim to none. Even though the announcement of the plan garnered significant attention, it appears unlikely that any of the companies approached will accept the deal; one firm has already rejected the offer, according to Buffett. More importantly, the plan would impose a pretty stiff premium on the bond insurers, while they would lose control of their low-risk and profitable municipal bond business.

Can you spare $15 billion?
The plan: When New York Insurance Superintendent Eric Dinallo implored some of Wall Street's top firms to kick in about $15 billion to help bail out the capital-squeezed bond insurers late last month, their responses were only moderately better than a cold-shoulder.

While major financial firms have a vested interest in keeping the insurers afloat, they have their own capital problems after losing billions as a result of the credit crisis.

The prospects: Possible. While a bank bailout plan seems unlikely, it is not off the table. A coalition of banks including Citigroup, BNP Paribas, Wachovia and UBS are reportedly working on a bailout plan of Ambac, the nation's second-largest bond insurer. One considerable risk, however, is that there is no indication that a one-time capital infusion would save these troubled firms' credit ratings. Sean Egan of independent ratings shop Egan-Jones has publicly stated that the bond insurers require somewhere closer to $200 billion in capital.

Short-seller solution
The plan: Pershing Capital Management's Bill Ackman has been one of the leading critics of the bond insurance industry, but offered up his own remedy for the crisis Wednesday. Under his proposal, the company's structured finance division would take control of its municipal business, with the two remaining under the umbrella of the holding company.

The prospects: Very doubtful. While the plan would insulate the municipal business and provide support to the structured finance division, it is unlikely that the industry would want Ackman to decide its fate, given his long-standing role as critic and industry short-seller. He stands to benefit if companies like MBIA continue to see their stock tumble even further. Just hours after Ackman pitched his idea, MBIA publicly rejected his proposal.

Buyer beware
The plan: Like the bank bailout program, the notion of a private equity, or distressed investor rescue doesn't remain out of the realm of possibilities. MBIA, for example, has raised about $2.6 billion in capital this year, part of which came from private equity firm Warburg Pincus. And famed distressed investor and billionaire Wilbur Ross has repeatedly said he is looking to invest in one of the bond insurers.

The prospects: Possible. While selling a stake to an outside investor would be a quick fix for the bond insurers, it remains to be seen if they could raise enough capital to satisfy Moody's and Standard & Poor's requirements to sustain their `AAA' rating. What's more, it would not necessarily cure the systemic problems that plague the industry, an area that some, including MBIA's newly appointed CEO Joseph "Jay" Brown, are hoping to fix.