All hail Eric Dinallo, the New York state superintendent of insurance!
If we are to believe the Financial Times, credit for the extraordinary stock market rally that closed out Wednesday's trading session on the NYSE should go to Mr. Dinallo, who has been meeting this week with New York bank executives and badgering them into providing as much as $15 billion of capital to shore up the sagging balance sheets and fragile credit ratings of a handful of bond insurance companies.
Bond insurers are supposed to be the backstop of modern financial markets. Their specialty: insuring against default on the complex derivative financial instrument that hedge funds and banks and other investors were buying and selling to protect themselves against the possibility of default. Unfortunately, it now turns out that many of these companies did not have adequate capital to make good their word when the defaults started rolling in. Whoops!
One How the World Works reader scoffed at my assertion in December that in terms of the systemic risk facing global markets, "The real thing to worry about is the health of the bond insurance industry."
But it is no joke. The bond insurers are considered to be dominoes that must not fall or they'll take everybody else down with them. One of the key factors setting off the global stock market panic earlier this week was the credit downgrade issued by Fitch to Ambac, a key insurer. As I wrote last month:
The problem is that if a bond insurer loses its Aaa rating, then so too may the bonds that it insures. Many institutional investors -- pension funds and the like -- are required by their own rules to only invest in Aaa securities. If credit ratings are downgraded, they would be forced to dump their holdings into a market where no one is particularly eager to buy. The resulting plunge in market value across the globe could be enormous.
This market crisis has not been prompted by macroeconomics as usual. Instead, it was triggered by fears for the architecture of the modern financial system -- and the potential devastating effects its collapse might have on the economy.
Ever since the credit squeeze began last summer, every part of the edifice of securitized markets has been scrutinized. Bond insurers, many believed, were the critical weak point in the structure.
So now, we are being told, jubilation reigns at the sight of regulators knocking heads. Hoorah.
Naked Capitalism has a well-reasoned, pessimistic take on why actually putting together a bailout will be tough. But How the World Works is content, for the moment, just to savor the ridiculous irony of this moment, to cherish this latest demonstration of how completely the rationale for recklessly deregulating financial markets from government oversight has been undermined in recent months.
An insurance commissioner is stepping in to make sure the entire edifice of market capitalism doesn't collapse.
Good luck, Eric.
UPDATE: A smart contribution on the economic significance of bond insurers from reader makoweb.
And another reader points to a very interesting New York Times profile of Eric Dinallo.