June 19 (Bloomberg) -- Hedge fund manager Bill Ackman, who correctly predicted shares of MBIA Inc. and Ambac Financial Group Inc. would tumble, said he now is betting against Financial Security Assurance Holdings Ltd.

Financial Security may be insolvent because it sold investment contracts backed by mortgage securities that have tumbled in value, Ackman, 42, told a conference hosted by law firm Jones Day yesterday in New York. Financial Security, a New York unit of Brussels and Paris-based Dexia SA, is one of two bond insurers to retain their AAA credit ratings after rivals were roiled by losses from collateralized debt obligations.

``The market has not woken up to FSA,'' said Ackman, who runs the $6 billion Pershing Square Capital Management hedge fund. Ackman says he will make hundreds of millions of dollars if MBIA and Ambac go bankrupt. ``FSA is AAA stable, just don't look too close.''

Like Armonk, New York-based MBIA and Ambac and the other bond insurers, Financial Security expanded into guaranteeing and investing in mortgage securities, Ackman said. Investors haven't scrutinized Financial Security's investments closely enough and the ratings companies are misjudging the risks, he said. The insurers expanded beyond municipal debt into insuring securities backed by subprime mortgages and other types of loans, a moved criticized by Ackman.

``It's a natural outgrowth of an industry that started in a low risk business,'' said Ackman. ``Over time, you start taking risks that you shouldn't.''

`Not a Concern'

Financial Security didn't insure the CDOs backed by subprime mortgages, which hurt the rest of the industry, Dexia board member Rembert von Lowis said today. The company showed ``superior credit underwriting discipline,'' he said. CDOs package pools of securities and slice them into pieces of varying risk.

By avoiding the worst-performing CDOs, the company ``has been able to preserve its financial strength and its ratings,'' said von Lowis. ``Our liquidity position is clearly not a concern.''

Ackman said he is betting against FSA by buying credit- default swaps on the insurance company's debt. The contracts jumped 205 basis points today to a record 660 basis points, according to broker Phoenix Partners Group, indicating deterioration in the perception of credit quality.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Taking Share

Ackman said he didn't short Dexia stock, which fell 6.3 percent to 12.36 euros in Brussels today.

Financial Security offers investment contracts with a return guaranteed by its insurance unit to municipalities and other investors looking to park the proceeds of bond issues. The value of some of the securities backing those contracts has tumbled so much that the company's liabilities of $20.4 billion exceed its assets of $16.2 billion, Ackman said.

Financial Security insured 64 percent of all municipal bonds sold in the U.S. during the first quarter, according to Thomson Reuters.

The company took share from MBIA and Ambac while their credit ratings were reviewed, deterring issuers from seeking their guarantees. Fitch Ratings and Standard & Poor's cut them to AA from AAA and Moody's may strip them of their top ratings.

`Business Opportunities'

Financial Security and Assured Guaranty Ltd.'s insurance unit were the only bond insurers to keep a top rating and stable outlook from Fitch, Moody's & S&P. Ackman said he hasn't analyzed Assured.

``We have seen unprecedented business opportunities over the last months, at extremely attractive returns and excellent credit terms, and we will do what it takes to further consolidate our position,'' von Lowis said.

In January, Ackman estimated MBIA and New York-based Ambac faced losses on home-loan securities of almost $12 billion each, a claim the companies disputed as recently as February.

Bond insurers wrote $400 billion of derivative contracts to insure CDOs and other securities, allowing policyholders to demand immediate payment for market losses if the insurer becomes insolvent. The threat of insolvency could lead to a downward spiral of bond insurers' credit ratings, Fitch said.

MBIA, Ambac, CIFG Assurance North America, Security Capital's XL Capital Assurance and FGIC Corp. have the guarantees with the similar clauses, according to company filings.

Insolvent?

XL, FGIC and CIFG may already be insolvent, Ackman said. Pershing Square profited as MBIA tumbled 91 percent in the past 12 months and Ambac plunged 98 percent in New York Stock Exchange composite trading. Security Capital is down 98 percent.

MBIA and Ambac risk becoming insolvent by eroding their statutory capital if they continue to set aside loss reserves at their recent pace, Ackman said. Under an alternative New York State Insurance Department test of solvency, which requires a company to be able to buy reinsurance for its guarantees using its assets, the companies already are insolvent, Ackman said.

Because MBIA has a surplus of $3.9 billion, insolvency is ``both highly theoretical and extremely unlikely,'' Kevin Brown, a spokesman for MBIA said in an e-mailed statement before Ackman spoke.

``There's not likely to be a man left standing'' in the bond insurance industry, Ackman said. ``This thing is over already, the market just doesn't know it yet.''

To contact the reporter on this story: Christine Richard in New York at crichard5@bloomberg.net

Last Updated: June 19, 2008 17:32 EDT