MBIA and Ambac sued by LA

The lawsuits are piling up. America is a very litigious country and when things go wrong people sue. That’s one reason one should realistically expect the courts to be clogged with all manner of suits on bond insurance, auction rate securities, CDOs, predatory lending, and on and on. The latest in this string comes from Los Angeles, where the city is looking for its pound of flesh from MBIA.

MBIA Inc., Ambac Financial Group Inc. and four other bond insurers were sued by Los Angeles for allegedly conspiring to maintain a credit-rating system that led local governments to buy “unnecessary” policies on their bonds.

City Attorney Rocky Delgadillo filed the lawsuit yesterday in Los Angeles Superior Court. The second-most populous U.S. city after New York says it seeks to recover damages it sustained by paying “millions” for guarantees that became worthless when the insurers lost their top credit ratings.

Borrowers in the $2.66 trillion U.S. municipal market have for decades paid insurers to guarantee their bonds, seeking lower interest costs by having AAA rated companies stand behind them. The way municipal bonds are rated has drawn fire this year from public officials who say it exaggerates default risk, forcing them to buy backing they don’t need.

“This dual credit rating scheme is maintained by bond insurers to take advantage of the taxpayers, by compelling cities to purchase unnecessary bond insurance,” Delgadillo said in a statement.

Hundreds of state and local governments were stung by higher borrowing costs this year after bond insurers, including Armonk, New York-based MBIA and Ambac, were stripped of their top credit ratings because of losses on securities linked to U.S. home loans. Officials including California Treasurer Bill Lockyer have said that insurance wouldn’t be necessary if state and local bonds were assessed using the same criteria as corporate debt.

Bloomberg, 24 Jul 2008

What’s relevant here to remember is that it is irrelevant whether misdeeds were done and who is to blame. What is relevant is that local and state governments have every incentive in the world to sue financial companies, if only for political reasons. Add to this the need for additional revenue after tax revenue shortfalls and we can assuredly expect more suits to come.

This is yet another reason the financial services sector is not going to be nearly as profitable for a long time to come.

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