June 4 (Bloomberg) -- New York Insurance Department Superintendent Eric Dinallo talked yesterday with Bloomberg's Michael McKee and Deirdre Bolton about the bond insurance industry, the outlook for municipal bonds and regulations on credit default swaps. State regulators are starting a new rating system for municipal bonds to aid insurance companies that hold about $500 billion of the securities. (Source: Bloomberg)

(This is not a legal transcript. Bloomberg LP cannot guarantee its accuracy.)

MICHAEL MCKEE, BLOOMBERG NEWS: Joining us now with more on the plan is New York State Insurance Commissioner, Eric Dinallo. Eric, thanks for being with us. So far only three insurers have had at least one ratings downgrade to junk status, and none of them were among the largest. Why the need to step in?

ERIC DINALLO, SUPERINTENDENT, NEW YORK INSURANCE DEPARTMENT: Because I think we're trying to be proactive about this and preemptive. I think there is the possibility always that some will go down to junk status. And there are others that we know are sort of on the edge. I think this is a good example of the regulators being pragmatic and stepping up and doing a positive thing for insurers, for the municipalities, the issuers, and the holders of the bonds. This is a case where if they do go to junk, the regulators, under sort of a rules-based regime, would have to make them either discharge the bonds out of the insurers' holdings or give them a big, big haircut. And that would not be fair because the underlying creditworthiness of the issuers hasn't changed.

DEIRDRE BOLTON, BLOOMBERG NEWS: How would the new rating system be different then?

DINALLO: Yes, there would be a rating system in the sense that once the wrappers, the insurance falls off or goes to junk, the underlying bonds would be basically viewed as junk by the regulators. So now we're going to step up the Securities Valuation Office that the New York State Department Supervisors would go in and take a look at the bonds. Say this was issued by such and such authority, and it really is an A-rated or AA or BBB, and give it the appropriate rating for the purposes of capitalization of the insurance companies.

BOLTON: The goal is clarity.

DINALLO: The goal is clarity, yes.

MCKEE: What qualifications does the NAIC have to actually do ratings? Is the organization capable of doing it or not, ratings?

DINALLO: Yes. Well we have 50 people at the SVO, Securities Valuation Office, that's been doing this historically. There are lots of illiquid, thinly traded, hard-to-value securities and bonds that we rate for the insurers who hold, the insurance companies will hold these as an asset in their asset-liability batch. And so all we're really doing is what we've always done. Here we're going to step it up. We'll probably maybe add some people to it during this close-to-crisis time when some of these could unfairly get downgraded, in a sense, but they're not really junk, but they would be effectively, titularly junk. And we're going to step in and try to rectify that.

BOLTON: And just sort of be a circuit breaker for cities, for towns, for hospitals?

DINALLO: Yes, exactly. And also the holders of the bonds, right? And also, most importantly, or as importantly, the insurance companies would either have to post up a lot more capital to continue to hold them, or under their bylaws, they may not be permitted to hold what would become junk, and they'd have to flush them into the marketplace.

MCKEE: All right. While we've got you, let me ask you about another issue, credit default swaps. You've been looking into whether or not you can claim jurisdiction over them as insurance. What have you found so far?

DINALLO: Well I think I'm getting more comfortable with the concept that there is a class of private default swaps that certainly look just like and are defined under the insurance law as an insurance contract, as an insurance product, where the person actually holds the underlying obligation, the bond, and goes into the marketplace and basically buys insurance through a CDS. That, to me, jurisdictionally and legally, I'm getting comfortable, pretty convinced that that's an insurance transaction. Whether we should regulate it or not, it's something that we should discuss. But in our studies, we've been talking to Wall Street, to hedge funds, to ISDA, and we've been having conversations with these groups about it. I'm getting pretty comfortable with it. And one of the things you learned along the way is that when you hold a derivative for hedging purposes, under GAAP, it's a different accounting than if you don't hold it. So there is that distinction in the marketplace. So it's not an impossible distinction, but it's something that we need to look at seriously before we fully regulate it.

MCKEE: All right. Eric Dinallo, thank you very much. We'll have you back and talk more about that.

(CROSSTALK)

DINALLO: Thank you, it's been a pleasure. Thanks a lot.

***END OF TRANSCRIPT***

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#<840630.1057402.1.0.82.31279.25># -0- Jun/04/2008 12:32 GMT

Last Updated: June 4, 2008 08:32 EDT