NY regulator: Bond insurers may be split up

NEW YORK/WASHINGTON (Reuters) -New York insurance regulator Eric Dinallo, who is heading up efforts to rescue bond insurers, is set to testify that he will consider allowing the companies to split their relatively strong municipal bond guarantee businesses off from the problem parts of their businesses.

According to prepared testimony obtained by Reuters, New York Insurance Superintendent Dinallo prefers to protect all parts of the bond insurers' business, but if it becomes clear that is not possible, his first priority is to protect municipal bond issuers and investors.

Reuters first reported on Tuesday that insurers could be split.

Dinallo is also looking at increasing regulation for the bond insurers, including potentially looking carefully at all of an insurers' positions, the way a rating agency would.

Dinallo is set to speak later on Thursday before the House Subcommittee on Capital Markets.

U.S. bond insurers, which guarantee more than $2.4 trillion of securities, are expected to make billions of dollars of payouts after guaranteeing repackaged subprime mortgages and other risky debt.

Those payouts may trigger ratings downgrades, force investors to sell billions of dollars of bonds, and lift borrowing costs for city governments and consumers.

The bond insurer problem must be fixed, or else it could become a "financial tsunami" that wreaks havoc on the broader economy, according to separate prepared testimony from New York Governor Eliot Spitzer obtained by Reuters.

MBIA Inc., the largest bond insurer in the world, is set to testify on Thursday that short-sellers are partly to blame for the decline in confidence in bond insurers, and plans to suggest regulators and lawmakers curtail the efforts of short-sellers, who profit when a company's shares decline.

Regulators are working with banks, private equity firms, and others to bolster the capital levels of bond insurers and prevent downgrades. But the discussions are difficult, according to Dinallo's testimony.

A group of banks is working with bond insurer Ambac Financial Group Inc on a possible rescue, while another group is working on a potential bailout of FGIC Corp.

Billionaire Wilbur Ross is considering investing money in a bond insurer, and Warren Buffett said earlier this week on television network CNBC that he has offered to reinsure three bond insurers' municipal bond exposure.

If strengthening a bond insurer is not possible, regulators will consider allowing the healthy municipal insurance businesses to split themselves away from the portion of the business that guaranteed repackaged subprime mortgage bonds and other troubled bonds, Dinallo's testimony says.

Municipal bond guarantees account for about two-thirds of bond insurers' businesses.

(Reporting by Dan Wilchins, Patrick Rucker; Editing by Valerie Lee)