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23, 2008 (LPAC)--, and now it is the bond insurers that are the problem, according to the financial press. The line is that if the bond insurers fail, the ratings on the bonds they insure will be reduced, forcing pension funds and other institutions to sell their holdings, causing a crash in the market for the municipal bonds, CDOs and other paper insured by these companies. That's a scary scenario, designed to make you feel that if we don't bail out the bond insurers, the whole system will collapse.
There's good news and bad news here. The good news is that the scenario presented above is not really true, but the bad news is that the situation is actually much worse.
Let's start with some basic cause and effect. It is not the collapse of the bond insurers that is jeopardizing the bond markets, but the collapse of the bond markets that is killing the bond insurers. Were the bond market sound, we wouldn't be hearing about bond insurance because it wouldn't be an issue. So the scenario being painted has it backwards. Bond insurance, like its larger credit derivatives sibling, is actually an accounting trick designed to help the financial markets portray all the worthless securities they are buying, selling and holding as having value. When you think about it, the whole concept of such insurance goes out the door in a systemic crisis, since both the instruments being insured and the institutions providing the insurance are part of the same system, and when the system goes, it all goes down together.
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