Banks sue MBIA over restructuring

A group of 18 large banks, including JPMorgan Chase (JPM), Bank of America (BAC), Morgan Stanley (MS) and UBS (UBS) among others, is suing MBIA (MBI). The suit, filed in New York, claims the bond insurer illegally split its business, leaving one unit effectively insolvent.

Why do the banks care about MBIA's restructuring? Well, many of them had bought credit derivatives from MBIA that insured them against losses on securities backed by subprime mortgage assets and commercial real-estate loans. Apparently, the banks have paid premiums for the guaranteed insurance protection.

But in February, after already suffering huge losses, MBIA separated its mortgage unit to start a municipal-bond insurance one, and took $5 billion out of the former to fund the latter. The original MBIA Insurance unit was left with $10 billion to back guarantees on about $240 billion in securities and bonds and its rating was downgraded to speculative grade of B3, or "junk," by credit-rating agencies.

So the banks now say the split and the transfer of $5 billion rendered MBIA insurance unable to to cover losses from those souring mortgage securities. The banks say the split was "fraudulent" and "an unlawful attempt to escape" its contractual obligations.

Not surprising perhaps, this wasn't the first lawsuit MBIA encountered on the matter as hedge funds and investment fund filed a similar one recently.

From its part, MBIA says -- at least regarding the previous suits -- that they are "without merit," and since New York regulators approved of the "transformation," any challenge to it should contest the official actions rather than being a civil case.

The suit, however, also claims personal gains to management and stockholders following the restructuring at the expense of business obligations, especially as it chose to spend more than $900 million repurchasing MBIA's own stock and debt -- money that could have been used to strengthen the balance sheet. Instead, policy holders could now face losses.

In this new environment, choosing personal gains over proper behavior should stop surprising anyone. What's more, regulators siding with some and not with others, bailing out some and not others, should also not surprise anyone either. While banks really don't need to incur anymore losses, and I do hope they don't, I do find some poetic justice in this case.

MBIA shares traded over nine percent lower in pre-market action.

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