The municipal bond insurance market took a beating during the financial crisis, virtually disappearing. The big insurers - Ambac, MBIA, insured 57.1% of municipal bonds at their peak in 2005. This month, just 8.7% of new issues were insured. Now the question everyone is asking is, do we need insurance, especially in the municipal bond market?
An article in this month's Bond Buyer entitled Insurers’ Obit Could Be Premature goes into great detail on the benefits and negatives of insurance and whether they think it will thrive. The bottom line is that for much of the municipal bond market, insurance has been a bit of a unecessary, and expensive luxury. Why? Because municipal bonds hardly ever default.
An investor who purchases Double A and above municipal bonds can be pretty confident that the bond will pay out and return princple. Even below that level, municipal bond defaults are rare and when they happen investors still recover most of their money. Indeed, according to several analysis done, municipal bonds in general are underrated compared to their corporate cousins. That means even lower rates munis have less default risk than comparably priced corporates.
The bond rating agencies are working on plans to address this ratings deficiency. If they do, then muni ratings will rise, further eliminating the need for insurance.
So, is insurance good? Should we want it? Not if it's not needed. Insurance adds billions to the cost of issuing bonds which comes out of the pocket of the issuing municipality and out of the pockets of investors. The only people who really benefit from insurance are big leveraged investors who purchased municipal bonds like commodities, ignoring underlying ratings because of the insurance. There no reason why we should have to subsidize their purchases.
And as we've seen, what's the point in paying for insurance if the insurers themselves get into trouble and can't meet their obligations. If the insurers back the municipal debt, who's backing the insurers?
But I forget, the taxpayer is always ready to back a financial business gone bad.