Ackman Floats Proposal to Save Bond Insurers

Activist investor William Ackman met Tuesday with New York State Insurance Commissioner Eric Dinallo to unveil yet another plan to bailout troubled bond insurance companies as banks and regulators continue to squabble over a way to save these floundering businesses from rating agency downgrades, CNBC has learned.

The plan by Ackman, who has been shorting shares of bond insurer MBIA , is a surprise since Ackman has released data he says shows that the bond insurers face at least $12 billion in liabilities each because of their decision to underwrite risky structured finance securities such as collateralized debt obligations, or CDOs, held by Wall Street firms and major banks.

For its part, New York seemed to react tepidly toward the deal in comments made Wednesday. Ackman's plan fails to preserve credit ratings for all policy holders, a state spokesman said.

"Our position is the more alternatives for the bond insurers the better," New York Insurance Department spokesman David Neustadt said. "However, Ackman's proposal would in all likelihood result in a substantial downgrade."

The bond insurers say that their problem is far smaller than what Ackman has said. Still, the problem is big enough for at least one insurer, Financial Guaranty Insurance, to say it will split its business to protect municipal-bond policy holders from being infected by far riskier CDOs, while the other major troubled insurers, Ambac and MBIA are considering similar moves.

Ackman’s plan isn’t so much a bailout as it is an attempt to call the bond insurers bluff about the potential size of their losses.

"Ackman's really calling their bluff here," said Joseph Mason, professor of finance at Drexel University. "They just want to continue business as usual."

Under the plan being discussed by Dinallo and the insurers, the companies would split their businesses into two separate units, one that insures municipal bonds and the other that insures CDOs. Profits from the muni insurance will flow to the holding company, thus securing the insurers’ AAA rating. These profits would be diverted away from the CDO portfolio, meaning that the banks that hold these securities would have to begin massive writedowns as their CDO lose their triple-A rating.

Ackman's plan treats all the policyholders equally, according to people briefed on the measure. The insurers would still be divided into two separate units so the muni-bond portfolio can maintain a triple-A rating, but any profits from the muni insurance - one of the most stable and profitable on Wall Street since municipalities rarely default on their debt - would flow to support the CDO portfolio.

Ackman has told New York State regulators, and officials from the US Treasury Department monitoring the situation that if the bond insurers are right, and their potential losses from CDOs are manageable, they will begin making money fairly quickly, while supporting the insurance policies not just of municipalities but also of banks holding insured CDOs.

But if they're wrong and he's accurate and the losses are much greater, the markets should determine the bond insurers' fate as they would likely loose their triple-A rating and would no longer be able to write new insurance business.

MBIA said in a statement "this proposal is simply a continuation of Mr. Ackman's campaign to profit from his short positions and credit default swaps in the bond insurance industry." Ambac
declined to comment.

A spokesman for Dinallo did not return a telephone call for comment.

As the regulators and banks discuss various bailout plans, the big bond rating agencies are threatening to downgrade MBIA and Ambac. FGIC has already lost its triple-A rating from the major bond rating houses, Moody’s, Standard & Poor's and Fitch. For that reason, people close to the talk say the pressure is on all parties to come up with a plan sooner rather than later before the rating agencies act.

In an interview on "Squawk Box," Mason said he favors a plan like Ackman's, which would prevent the companies from paying dividends from municipal bonds to shareholders and instead direct proceeds to go directly into capital to help sustain credit ratings.

"You keep the profitability of that good portfolio within that portfolio, don't allow dividends up to the holding company," Mason said. "The key to all this is to prevent the insurers from continuing to pass out dividends from the good business out to investors."

- Reuters contributed to this report.

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