Herrera's Municipal Bond Insurance Suit Shows Another Facet of Subprime Mortgage Crisis
Litigation Alleges Scheme to Fleece Government Entities, Withhold Information About Financial Exposure in High-Risk Subprime Market
SAN FRANCISCO (Oct. 8, 2008) -- City Attorney Dennis Herrera today filed suit against five municipal bond insurers for an elaborate web of anticompetitive practices, negligence and fraud that has been exposed by the recent meltdown in the subprime mortgage market. According to the civil lawsuit filed in San Francisco Superior Court today, bond insurer defendants named in the case schemed to force local governments in California to needlessly purchase bond insurance so they could obtain higher credit ratings and more favorable interest rates. According to Herrera's 60-page complaint, the defendant insurers abused their market dominance by illegally perpetrating a dual rating scheme, which systematically rated public entities lower in credit-worthiness than their private sector counterparts -- despite evidence showing corporations to be five times more likely to default on bond obligations than governments.
But the anti-competitive scheme reached "disaster levels," according to Herrera's complaint, when the defendants insured hundreds of billions of dollars in subprime loans and related financial products, without ever disclosing to their government sector customers the extent of their exposure in the high-risk subprime market. With the wave of subprime mortgage failures, the bond insurer defendants' artificially inflated credit ratings were downgraded -- tanking, in at least two instances, to "junk status" -- leaving local governments with worthless insurance coverage for which taxpayers had paid millions, and forcing many municipalities to refinance their debt obligations.
"These defendants manipulated demand for insurance we never needed, based on creditworthiness they never had, to cover bets they should never have made," Herrera said. "It's the antitrust equivalent of nesting dolls: a scam inside a fraud inside a rip-off. And now that the scheme has been revealed, taxpayers are left holding the bag. With our lawsuit today, San Francisco is joining similar efforts by the cities of Los Angeles, Stockton, Oakland and others to not only recoup losses, but to aggressively punish marketplace greed that ultimately hurts everyone-from working families and taxpayers to the investment community and honest competitors."
The five municipal bond insurers named in Herrera's lawsuit are Ambac Financial Group Inc., XL Capital Assurance Ltd. Armonk, Financial Guaranty Insurance Company, and CIFG Assurance North America, Inc., which are all based in New York City, and MBIA Inc., which is based in Armonk, N.Y. Causes of action alleged in Herrera's civil action include breach of the covenant of good faith and fair dealing; fraud and deceit; breach of contract; negligent misrepresentation; negligence; and violations of the California Cartwright Act, a state antitrust law. The suit on behalf of the City and County of San Francisco seeks unspecified damages, injunctive relief, and attorneys' feels and costs. Co-counsel on the case are from the Burlingame, Calif.-based Cotchett, Pitre & McCarthy and the San Francisco-based Renne Sloan Holtzman Sakai LLP.
The case is City and County of San Francisco v. AMBAC Financial Group, Inc. et al, San Francisco Superior Court, filed October 8, 2008.
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