SAN FRANCISCO (MarketWatch) -- Banks' efforts to bail out troubled bond insurers won't change the ultimate losses from the industry's foray into the riskier structured-finance business, but will just transfer the pain to another sector, according to hedge-fund manager Bill Ackman.
In testimony due to be delivered to a congressional committee Thursday, Ackman also proposed ways that a crisis in the municipal-bond market may be averted. MarketWatch obtained an advance copy of his prepared remarks.
Ackman, who runs Pershing Square Capital Management LP, has been shorting or betting against the holding companies of leading bond insurers MBIA Inc. (MBI) and Ambac Financial Group (ABK) .
New York Gov. Eliot Spitzer, New York State Insurance Superintendent Eric Dinallo and executives from Fitch Ratings, Ambac and MBIA are also due to testify during Thursday's House Financial Services subcommittee hearing on the state of the bond-insurance industry.
MBIA plans to ask regulators to prevent what it calls market manipulation by short sellers, specifically targeting Ackman, CNBC reported Wednesday. The two have sparred many times in recent years.
MBIA also plans to say that some bond insurers may not survive the current crisis. In addition, the company will say that the way agencies rate bond insurers may need to be changed, CNBC said. Elizabeth James, a spokeswoman for MBIA, declined to comment.
Ambac Chief Executive Michael Callen will tell lawmakers that the bond insurer isn't struggling to meet current obligations, but needs to stabilize its ratings so that it can pursue new business, the company said in a statement late Wednesday.
Callen will also "discuss some of the factors that have heightened speculation and created undue fear in light of the exaggerated and inflated estimates related to losses," Ambac added.
Bond insurers guarantee more than $1 trillion of muni bonds, providing AAA backing to help cities, school districts and other municipalities borrow more cheaply. But losses on more complex securities known as collateralized debt obligations, or CDOs, have imperiled the bond insurers' top ratings, throwing some parts of the muni market into turmoil.
Regulators have now stepped in to try to avert a wider crisis. The New York State Insurance Department, headed by Dinallo, is currently focusing on banks and brokerage firms that are big counterparties to the bond insurers. The regulator is trying to encourage these companies to inject new capital into specific bond insurers to prevent them from losing their AAA ratings.
Ackman said that such a plan is "simply an artificial loss-deferral exercise," according to his prepared testimony. "The problem is that the math doesn't work. The amount of losses doesn't change whether the losses are borne by the banks or the insurers."
Banks are considering such bailouts because they bought guarantees from bond insurers to hedge their own CDO exposures. If their counterparties are downgraded or if a major bond insurer runs out of money to pay claims, banks may suffer another round of painful write-downs.
To avoid this, banks are trying to take advantage of lower regulatory capital and rating-agency standards for the bond insurers. The current system gives roughly eight times more credit to one dollar of capital held by a bond insurer vs. one dollar held by a bank, according to Ackman.
"If offered the choice, what bank wouldn't invest $1 billion to avoid $8 billion of write-downs?" he asked.
A more efficient solution would involve the banks taking the extra write-downs and being more transparent about their exposures. These firms could then raise more capital or be bailed out themselves, which would be a better option than "the indirect method of propping up ailing bond insurers," Ackman said.
Still, given his short positions in Ambac and MBIA, Ackman could lose money if these bond insurers are salvaged by their bank counterparties.
But he also noted that Pershing is a big investor in U.S. companies like Target Corp. (TGT) , Sears Holdings Corp. (SHLD) and Barnes & Noble Inc. (BKS) , which are vulnerable to a slowdown in the economy and consumer spending.
The consumer slowdown is partly driven by the credit crisis, and fixing the bond-insurer problem may help alleviate that, Ackman said.
Muni ratings
The hedge-fund manager also criticized the rating agencies for underrating muni bonds, arguing that this created the opportunity for bond insurers to charge premiums to bolster creditworthiness for municipal borrowers rated AA or lower.
The agencies currently use the same ratings for structured securities as they do for corporate debt and municipal bonds. However, recent studies have shown that muni bonds default much less than corporate bonds and structured securities like CDOs. The mortgage crisis has shed harsh light on such differences.
Ackman said that in future muni bonds should be rated on the same scale as corporate bonds. That would immediately improve muni-bond ratings, avoiding the possible forced sale of securities by investors who can't hold lower rated debt by law, he commented. It would also reduce the need for bond insurance, Ackman said.
The Securities and Exchange Commission currently requires that money-market funds sell securities that fall below AA. This rule should be clarified to state that the corporate-ratings method be used for this test in future, he added.
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