WASHINGTON (Reuters) - The bond insurer problem must be fixed, or else it could become a "financial tsunami" that wreaks havoc on the broader economy, New York Governor Eliot Spitzer is due to tell the Congress Thursday.
A copy of Spitzer's prepared testimony was obtained by Reuters on Wednesday.
New York State Insurance Superintendent Eric Dinallo is working with banks on rescue plans for several bond insurers, which guarantee more than $2.4 trillion of debt and are expected to suffer big losses from insuring bonds linked to subprime mortgages and other risk assets.
Those losses threaten the top credit ratings that insurers need to win new business. If insurers are downgraded by ratings agencies, investors that can only hold top-rated bonds may have to sell billions of dollars of securities, lifting borrowing costs for cities and consumers alike.
About two-thirds of bond insurers' business is guaranteeing municipal debt, and one-third is insuring repackaged consumer debt.
Higher borrowing costs and general credit market difficulties "could be a financial tsunami that causes substantial damage throughout our economy," Spitzer said in the testimony prepared for delivery to a House of Representatives Financial Services subcommittee at 11:30 a.m. EST on Thursday.
Spitzer's comments echoed recent remarks from Deutsche Bank Chief Executive Josef Ackermann, who said that bond insurer downgrades could send shockwaves through financial markets.
Regulators hope to help bond insurers keep their top credit ratings, but are also looking at protecting only the insurers' municipal bond insurance segments, Spitzer said.
"We have been clear from the beginning that municipal investors cannot be allowed to suffer from problems caused by another sector of the market," he said.
BLAME IT ON BUSH
On Thursday, the New York Democrat in a CNBC interview laid blame for the subprime crisis and its broader fallout on the Bush Administration.
Spitzer recalled that several years ago the U.S. Office of the Comptroller of the Currency went to court and blocked New York efforts to investigate the mortgage activities of national banks. Spitzer argued the OCC did not put a stop to questionable loan marketing practices or uphold higher underwriting standards.
"This could have been avoided if the OCC had done its job," Spitzer said in the interview. "The OCC did nothing. The Bush Administration let the housing bubble inflate and now that it's deflating we're dealing with the consequences."
"The real failure, the genesis, the germ that has spread was the subprime scandal," Spitzer said. Fraudulent marketing and teaser rates that later ballooned were practices that should have been stopped.
"When mortgages are being marketed, there is a marketplace obligation to ensure the borrower can afford to pay back the debt," he said.
The subprime problem, he said, spread into other markets and is now causing pain for individuals, who may not be able to get mortgages, and giant bodies such as the Port Authority of New York and New Jersey, whose latest bond auction fell through, he said. He also linked the mortgage crisis to the current struggles of the bond insurers.
Yet Spitzer deflected questions about New York state's role 10 years ago in allowing bond insurers, which had long guaranteed safe public-sector bonds, to back risky mortgage bonds and complex structured debt.
(Reporting by Patrick Rucker in Washington and Dan Wilchins in New York; Writing by Dan Wilchins; Editing by Tomasz Janowski and Dave Zimmerman)
