Treasury optimistic on bond insurance

By Lisa Lambert

WASHINGTON (Reuters) - The U.S. Treasury Department is optimistic that problems in bond insurance will be worked out and progress is being made, a senior Treasury official said on Thursday.

Treasury Undersecretary for Domestic Finance Robert Steel told the Reuters Housing Summit he was encouraged that various groups with an interest in the bond insurance market -- from the New York state insurance regulator to the insurers -- are communicating.

"It's a good long list of people who are adjacent to this issue. The good news is that it seems all of those people are speaking," he said. "There are lots of incentives for people to figure this out, and it seems to my mind, progress is being made and ideas are being shared."

When asked if the insurance companies should recapitalize or be split into two businesses, he said that "from an intellectual view" he agreed with the first suggestion.

"Assuming that these are going to be ongoing entities, then they'll need to have fresh capital," he said.

Having insurance companies increase their capital has been suggested as one solution to the problems triggered when ratings agencies lowered or threatened to lower the major bond insurers' "AAA" ratings.

Over the last few weeks, MBIA Inc (MBI.N: Quote, Profile, Research, Stock Buzz), the largest U.S. bond insurer, and Ambac Financial Group Inc (ABK.N: Quote, Profile, Research, Stock Buzz) have tried to raise funds.

Another option presented by New York Insurance Superintendent Eric Dinallo has been to create a "good bank-bad bank plan" that would split the companies' healthier municipal bond insurance from its more troubled enterprise of backing mortgage debt.

Steel also said the U.S. Treasury was watching the auction-rate bond market with vigilance, after a string of failed auctions over the last several weeks.

Auction-rate securities are long-term debt with interest rates that are reset regularly by auction. But over the last few weeks some of the auctions have failed, forcing the debt to reset to a default interest rate, sometimes as high as 20 percent.

"Most of these things were understood," Steel said about the risks the auctions would fail. "They might have misapplied the probability of them occurring."

(For summit blog: summitnotebook.reuters.com/)

(additional reporting by Kevin Drawbaugh; editing by Jeffrey Benkoe)