Collateral damage from bond insurer downgrades

An individual bond is rated based on the rating of the company that insures it. A bizarro concept, when you think about it. Shouldn’t a bond be rated on its own merits? But they aren’t.

This cozy system worked fine, generating lots of income for all concerned, until the bond insurers got downgraded. This meant that all the bonds they insured got downgraded too, which in turn forced higher the interest that municipalities, hospitals, and the like must pay to bondholders.

Their financial situation hasn’t changed, but they must pay more.

The interest rate on $44 million of bonds for the San Francisco Ballet more than doubled to 12 percent last month as Financial Guaranty Insurance, which insured the debt, was cut below investment grade.

Isn’t insurance is supposed to decrease risk, not increase it?