Too big to fail?

Further, while some in Wall Street circles have argued that an operations failure of MBIA and Ambac, stemming from a downgrade from their Triple-A rating or due to other circumstances, would not have larger consequences for the credit and equity markets, Wang said "these critics are deluding themselves."

"An operational failure by MBIA or Ambac would have serious consequences for the bond market and for the financial system," Wang said. "We're talking about another major stress on several banks and on a financial system already weakened and under stress. Bond market interest rates would soar for municipalities, corporates, and non-profits, and others. This is a public interest issue of the first order, which is why [New York] Gov. Spitzer has given the private sector a deadline to address re-capitalization." Wang added that he does not own MBIA's or Ambac's shares.

Gov. Spitzer's directive

In Congressional testimony yesterday, New York Gov. Eliot Spitzer gave a three-to-five-day time frame for the bond insurers to raise much-needed capital or find other ways to resolve their problems, The Wall Street Journal reported Friday. (Subscription required.)

Speaking before a House Financial Services subcommittee, Gov. Spitzer effectively threatened that state regulators -- namely, Eric Dinallo, the superintendent of the New York State Insurance Department -- would "have to act" and potentially "strip the municipal businesses" from the bond insurers if they didn't find a solution soon, The Journal reported.

Economist Steve Affinito said New York State's effort could involve the aforementioned separation of the municipal bond insurer / mortgage insurer businesses lines, but Affinito, like Wang, favored a direct re-capitalization by the private sector; if not, then a re-capitalization coordinated at the federal level, not the state level, directed by the U.S. Treasury and/or the U.S. Federal Reserve.

"Ideally, the major banks involved with the most to lose from MBIA's and Ambac's problems should supply the bulk of the funds. Concerning Spitzer's idea, New York taxpayers can reasonably ask 'Why am I being asked to save an insurer who insures bonds from another state and/or mortgages from another state?' I would have problems with that type of New York State plan, from a jurisdiction standpoint and from a taxpayer obligation standpoint," Affinito said. "But I see where Gov. Spitzer is coming from. He sees a potential train wreck ahead on his watch, one where New York State's Insurance Department has regulatory authority, and he wants to avoid that, not to mention the direct impact on New York State's borrowing costs, and its economy." Affinito added that he does not own MBIA's or Ambac's shares. Affinito also said he is a resident of and a taxpayer in the state of New York.

Stressed credit market

One example of the stress the unresolved status of MBIA and Ambac is putting on credit markets is the recent Port Authority of New York & New Jersey's securities offering. A quasi-public agency with substantial cash flows and a high credit rating, the Port Authority of New York & New Jersey bond's reset at 20%, up from 4.3% a week earlier.

Some have said a bailout would be inappropriate and tantamount to rewarding those, the critics argue, who are most responsible for the current credit crunch: MBIA and Ambac.

Wang said that analysis is "simplistic at best, and injurious at worst." Wang said dozens of players are responsible for the current credit crunch, from "banks who pushed mortgages on barely qualified borrows, to appraisers who artificially increased appraisal reports, to (some) borrowers who knowingly took on too much mortgage debt or otherwise overextended themselves, to mortgage lenders who created absurd mortgage products that were destined to fail."

In Thursday Congressional testimony, Gov. Spitzer agreed. "Stopping the lenders and mortgage brokers from making inappropriate mortgage loans to borrowers who couldn't afford them would have been the best way to prevent the subprime problems," Spitzer said, The Journal reported.

"There will be plenty of time to investigate and determine blame for mortgage foreclosures and credit market stress later," Wang said. "Right now, public and private officials must focus on what is paramount, restoring the integrity and proper function of the credit markets."