Connecticut Attorney General subpoenas bond insurers

By Dan Wilchins and Dane Hamilton

NEW YORK (Reuters) - The Connecticut Attorney General said he has subpoenaed bond insurers, including MBIA Inc (MBI.N) and Ambac Financial Group Inc (ABK.N), as part of a widening probe into who is to blame for the U.S. subprime mortgage crisis.

The subpoenas are the latest affliction plaguing the bond insurers, who according to analysts at CreditSights are likely to lose their top credit ratings, despite state regulators' efforts to rescue the industry.

Connecticut Attorney General Richard Blumenthal said his office is looking into whether the bond insurers charged excessively high rates or faced conflicts in selling bond insurance to municipal governments issuing debt.

The subpoenas are part of a larger probe into banks and rating agencies, who combined with bond insurers are seen by some analysts as having enabled lending practices that triggered the subprime mortgage crisis.

If bond insurers lose their top credit ratings, due at least partly to losses relating to the subprime mortgage market, funds may be forced to sell off billions of dollars of insured debt.

Regulators are hoping to prevent those forced sales, which could lift borrowing costs for city governments and consumers. U.S. bond insurers guarantee more than $2.4 trillion of debt.

Despite potential ratings downgrades and a regulatory probe, some investors are still hopeful regulators can organize a solution to the bond insurers' problems.

Share prices of the two largest bond insurers, Ambac Financial Group Inc and MBIA Inc, surged on Tuesday amid talk that ratings for Ambac's main insurance unit were close to being affirmed.

Adding to that concern, $446 million of bonds insured by Ambac and linked to a Las Vegas monorail project could default in as soon as two years, Moody's Investors Service said on Tuesday.

These expected losses are eating away at the insurers' capital, but the potential for rating agency downgrades makes raising new capital difficult.

New York State Insurance Superintendent Eric Dinallo is working with banks to arrange to rescue the industry, people briefed in the matter said last week, but there are so many competing interests involved that any solution will not likely come in time, CreditSights said.

A REAL POSSIBILITY

Analysts at research firm CreditSights wrote on Tuesday that multi-step downgrades are a real possibility now, because rating agencies are setting high capital requirements but the public markets for raising capital seem closed to the bond insurers now.

"Essentially the markets and the rating agencies have set into motion a self-fulfilling prophecy which could now lead to further downgrades," CreditSights analysts wrote.

People briefed on Dinallo's talks with banks last week said the regulator was pressing banks to provide up to $15 billion of emergency backup credit. A person briefed on the matter said on Monday that the regulator and banks are more likely to try to selectively rescue bond insurers.