WASHINGTON - The National League of Cities and other government groups claim that states and localities are well suited to create a national nonprofit credit enhancement provider for municipal bonds because they have a long history of establishing pooled insurance programs. But some market participants are concerned that such an entity would be limited in its ability to boost investor demand for munis.

The market participants also say that if the NLC establishes a credit enhancer - which it hopes to do by as early as this summer with help from the federal government - it will need to overcome several obstacles. Chief among them will be gaining market acceptance, which will require structuring the entity to shield it from political decisions influencing its underwriting process as well as to ensure that it receives triple-A ratings from credit rating agencies.

"There are several unknowns," said one source. "And relative to trading values, it will take some period of time before the new entrant becomes more acceptable and less distinguishable from other insured municipal debt."

That process could take a year or more once the new credit enhancer is off the ground, the source said.

Another concern is that while the new credit enhancer would spur some additional demand for munis, it would not have a widespread impact on the muni market because of risk limitations that prevent mutual funds and other investment companies from having too much exposure to any single insurer, said Matt Fabian, managing director at Municipal Market Advisors.

"Any new private insurer is going to have to wrestle with single-risk limitations, so their penetration in the market will be limited," he said. The NLC idea "will certainly spur demand, but it's not going to fix the market," he added.

Rather than create one bond insurer, Fabian said the federal government could provide seed money to 50 small state-specific insurers that would each be structured like the Texas Permanent School Fund, in which the state acts as guarantor of state and local government-issued obligations in return for a fee.

The concerns stem from an NLC-led commission report in January that called for the possible creation of a mutual insurance company that would back fixed-rate debt, including general obligation bonds and revenue bonds for essential government services.

The commission was formed because rating downgrades for monoline bond insurers have caused problems for many issuers, particularly municipalities and school districts with underlying ratings below double-A that have had to pay much higher premiums to attract investors without insurance.

But despite the challenges to getting a mutual insurer off the ground, members of the NLC commission have said that they are optimistic about the possibility of achieving triple-A ratings for such an entity after having met with credit rating agency analysts and the staff of the New York Sate insurance superintendent this month.

Bob Inzer, chairman of the NLC commission and clerk of the courts for Leon County, Fla., acknowledged yesterday that risk limitations would be an issue today based on the models funds have for monoline bond insurers. But in the future, the models could be different, he said.

"The existing providers are basically in business to maximize profit to shareholders, but this entity would be created with a completely different focus, to minimize cost and minimize risk," he said.

Proponents of the NLC proposal note that localities have about 35 years of experience establishing risk management pools, going back to when Texas established the first one in 1973 to provide workers compensation coverage. The need for pooled coverage grew as a series of court battles and state legislative actions chipped away at the concept of governmental immunity, which made it difficult for localities to find and afford insurance, particularly liability coverage.

Today, about $60 billion to $80 billion in local capital is tied up in about 500 risk management and benefits pools across 49 states, said Harold Humpford, the chief executive officer of the Association of Governmental Risk Pools. About 74,000 local governmental units, representing 85% of all local governments, rely on such pools for managing workers compensation and property liability risks as well as employee benefits.

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