LOS ANGELES (CN) – The City of Los Angeles claims AMBAC Financial Group and five other corporations conspired to defraud it of hundreds of millions of dollars by selling it worthless bond insurance. In another fallout from the subprime real estate disaster, the City claims the bond insurers sold “hundreds of millions of dollars” in policies that are “now worthless in many respects due to the failing financial conditions of the bond insurance companies.”
Defendants in the Superior Court lawsuit are AMBAC Financial Group, MBIA Inc., XL Capital Assurance, ACA Financial Guaranty Corp., Financial Guaranty Insurance Co., CIFG Assurance North America, Jason Kissane, and Neil Pack. Kissane is managing director of MBIA’s global public finance division and head of its San Francisco office. Pack is managing director and head of the public finance division in CIFG’s western region.
Los Angeles says the defendants created their own disaster by taking “hundreds of millions of dollars in premiums from California public entities, [and] then insured hundreds of billions of dollars of subprime loans. The insurer defendants never disclosed the extent of their exposure to the subprime market but rather represented to plaintiff Los Angeles and other California public entities that the bond insurance they were selling would improve their credit rating and lower the interest rate they would have to pay. In that way, the defendants sold worthless bond insurance.”
The city cites testimony the Connecticut Attorney General delivered to the House Committee on Financial Services on March 12: “We know there was a concerted effort among supposed competitors to maintain the dual rating system and kill attempts at reform. There were discussions amongst insurers aimed at retaining the dual rating system when at least one rating agency suggesting modifying or eliminating it. The effect of these activities was clearly to maintain prices and prop up the market for bond insurance. Such misuse or market power and restraint of competition is plainly anticompetitive and anti-taxpayer, causing direct harm to municipal and state customers issuing bonds.”
The dual rating system refers to bond-rating agencies assigning different ratings to public entities and to private ones. “As a result of different rating systems, however, these two entities, who are otherwise similar, may receive different ratings, e.g., the public entity may be rated ‘A’ while the corporate entity may be rated ‘AAA.’ Despite the fact that these entities possess the same default risk, the public entity’s borrowing costs are significantly higher than the corporate entity. This is the result of the dual bond rating system created by the Credit Rating Agencies with is now the subject of great debate and investigation. Through this discriminatory system, public entities have been forced, and the taxpayers who support those public entities, to pay the insurer defendants unnecessary insurance premiums.”
The City says this is particularly outrageous as history shows that the default rate for municipal agencies is only one-fifth as high as corporate defaults. Therefore, the “defendants basically receive hundreds of millions of dollars for doing nothing as municipalities rarely, if ever default.” The City claims that most bond insurers will insure “only those municipal bonds that had a zero percent chance of defaulting”.
It continues: “This demanding standard that the insurer defendants have levied against the plaintiffs and other California cities and municipalities is in complete contrast to their own irresponsible behavior in insuring hundreds of billions of dollars of high risk subprime mortgage instruments and other complex leveraged instruments based on subprime mortgage instruments. …
“The misconduct of the defendants was solely for the financial benefit of the defendants. In the face of the downgrading of the insurer defendants, Moody’s has now all but admitted that the dual rating system is flawed and is overhauling and updating all of its municipal bond ratings. Initial estimates suggest that a large number of municipalities and public entities that were formerly below ‘AAA,’ and thus had to buy bond insurance, will be rated ‘AAA.’ Standard & Poor’s has now upgraded more than 5,000 municipal bonds and has indicated further upgrades may be forthcoming. This dual rating system, which was illegally propped up by the bond insurance companies, was unfair. Even accepting this system as unfair, the insurer defendants had no business exposing themselves to hundreds of billions of dollars of high risk sub-prime liability while simultaneously insuring municipal bonds.”
The City demands damages for breach of faith, fraud and deceit, breach of contract, negligent misrepresentation, negligence, and violations of the California Cartwright Act. It demands punitive damages.