Bond Insurers Deepen Sub-Prime Crisis

The sub-prime market is focused on providing home loans to those with limited or poor credit histories.

Many of these mortgages were converted into financial instruments and sold on to investors including banks.

But a series of interest rate rises over the past two years has meant many sub-prime borrowers could no longer afford their monthly payments, causing them to default.

This led to a steep fall in the value of investments linked to sub-prime loans and has caused many banks to report massive losses.

Bond Insurers (like Ambac, MBIA) sells policies that protect banks against losses on investments backed by sub-prime mortgages. To do that it relies on a strong credit rating.

But analysts are concerned that the insurers will not be able to pay out.

Credit rating agencies Moody's and Standard & Poor's have threatened to downgrade the firms on fears they do not have the ability to pay claims on mortgage-backed securities that soured as a result of the credit crisis.

A poor rating would force the banks to acknowledge a drop in the market value of bonds insured by the guarantors.

Some fear that if bond insurers like Ambac and MBIA were stripped of their 'AAA' rating, that could spark the next wave of writedowns at the nation's largest financial firms.

To date, major financial firms have endured losses totaling more than $100 billion as a result of bad bets on mortgage securities and some analysts are warning that that number could grow.

Right now, the credit rating agency estimates that about 20 different financial institutions have about $120 billion worth of credit default swaps on asset-backed collateralized debt obligations guaranteed with different bond insurers.

Moody's said that financial firms may have to ante up as much as $30 billion in reserves to offset worsening conditions related to the bond insurance industry.