Battered investment banks trying to dump billions in soured mortgage securities are being challenged by struggling insurance companies that claim such efforts could cause them further pain.
It's a battle that pits large financial firms like UBS, Merrill Lynch and Citigroup against insurers MBIA, Ambac and others. These insurers, which the industry refers to as "monolines," provide specialty insurance used to protect investors from losses on various types of debt securities.
At issue is a type of protection that banks have obtained against defaults that is now preventing them from purging portions of their holdings of arcane mortgage securities known as collateralized debt obligations.
Under the terms of this protection, the banks need approval from the monolines in order to unwind these securities - and obtaining that OK is proving difficult in some cases.
For the past several months as the credit crunch has pummeled mortgages and other forms of debt, a lot of collateral used to form CDOs has triggered defaults due to rating agency downgrades. As a result, if the banks begin dumping these problem securities, financial guarantors would be forced to pay default claims almost immediately - a tall order for companies whose financial future is already murky.
Typically, monolines pay out claims on losses over a period of 20 or 30 years, but the types of sales that the banks are looking to score would accelerate those payments and further hammer companies already hurting.
The banks appear to recognize that the insurers are unlikely to be able to cough up the cash needed to pay off these losses.
That has led to discussions about whether to waive claims payments in exchange for cash or warrants in certain publicly traded monoline companies.