New York's top insurance regulator yesterday said he hopes to have a new set of regulations written for bond insurers by the middle of this year, which would further define the types of policies they can and cannot write.

Speaking at a Crain's New York Business breakfast yesterday, New York insurance superintendent Eric Dinallo told the audience that he thinks the financial guaranty companies overstepped when they began to write policies on collateralized debt obligations and credit default swaps.

"Clearly a line was crossed concerning the CDS and other events of default which we normally don't want to mix with the insurance book," Dinallo said to the audience.

Insurance regulators did not stop the financial guarantors from expanding their businesses out of the muni market, a dynamic that one of the moderators suggested could nevertheless continue to play out in future business cycles. In response, Dinallo said his understanding of the current crisis was that the bond insurers' were encouraged to expand into structured finanace by the rating agencies, who asked them to expand their books of business.

"From what I have learned so far, the bond insurers were encouraged by the rating agencies to improve their return on equity and seek diversification through doing this structured business," Dinallo said.

When asked about this same point earlier this month, Standard & Poor's executive vice president Vickie Tillman told The Bond Buyer: "We never encouraged bond insurers to go into structured finance, that was up to them."

Fitch Ratings and Moody's Investors Service did not return calls seeking comment by press time.

Regardless of what led to the current turmoil, the current market wants a solution. And in this, Dinallo has been proactive in bringing banks and counterparties to the table. He invited Warren Buffett to enter the market with the formation and fast-track licensing of Berkshire Hathaway Assurance Corp., helped MBIA Insurance Corp. with the issuance of their $1 billion in surplus notes, and suggested various ways of addressing capital shortfalls.

However, the solutions and the sweeping authority with which he has demanded solutions has angered some Wall Street banks and market participants who wonder whether he is overstepping his bounds.

Insurance regulators are granted powers to protect policyholders - both the municipalities and the Wall Street counterparties exposed to the insurers, Dinallo said - by ensuring that companies remain solvent, and able to pay claims. But the problems in the bond insurance industry have never been just about the companies' solvency.

"We regulate and worry about the solvency of insurance companies, their claims paying ability," Dinallo said. "But this is the one area of insurance where the rating of the company was as important as their solvency."

Using that authority, Dinallo has demanded solutions, some of which are now moving toward implementation. MBIA has been removed from credit watch by Moody'sand Standard & Poor's, a plan to save Ambac Assurance Corp.'s triple-A rating appears imminent, and both MBIA and Financial Guaranty Insurance Co. have talked about splitting their books of business.

Earlier this week Standard & Poor's affirmed Ambac's AAA rating, but kept the bond insurer on credit watch with negative implications.

Dinallo would not say when he expected the Ambac plan or further developments with FGIC to be announced.

"I think on Ambac we're in the eighth inning," Dinallo said. "FGIC to me is something that needs to get turned to immediately, we don't want to see litigation break out there. It's downgraded enough that we might begin to think about a private equity play or will it have to be a good book/bad book."

Dinallo said private equity firms and sovereign wealth funds have shown some interest, and investor Wilbur Ross has as well, based in part on the options they can get for an equity infusion. Dinallo said the equity could be flipped, a year or two down the line with a rights offering. This is part of the plan being contemplated by the group of eight banks looking to support Ambac, which CNBC said yesterday has expanded to include Cerberus Capital Management LP and two other banks.

The way it could work, the bond insurers would get to keep a greater percentage of ownership if they suffer fewer losses, but if the losses mount, investors would have the option to take more ownership of the good book of business, Dinallo said.

"If there is value of an upside for equity investments it's in that optionality," Dinallo said.

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