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MBIA insures bonds. Specifically, its core business since its inception in 1973 has been insuring domestic municipal bonds (in fact, the company used to be known as Municipal Bond Insurance Association). Few municipalities are AAA rated, as MBIA was until 2008, so to lower interest costs and make it easier to sell their debt offerings, municipalities paid MBIA to insure their bonds, thereby making them AAA rated. This was a stable, profitable, steadily growing, minimal-loss business that MBIA used to dominate, achieving a 42.4 percent market share in 1997.

Because of its apparent profitability, however, the business of insuring muni bonds became much more competitive over time and MBIA 's market share fell steadily. Despite this dramatic loss of share in its core business, however, until 2007 MBIA continued to grow its earnings, book value, and premiums at its historic low-teens to mid-teens rate.

How was this possible? Simply because MBIA aggressively began insuring a wide range of bonds backed by subprime loans on new and used autos, aircraft leases and equipment trusts, credit card receivables, investor-owned utilities, health care equipment financing, student loans, emerging market CDOs, credit default swaps, and, most ominously, structured finance products based on U.S. mortgages like residential mortgage-backed securities (RMBSs) and collateralized debt obligations (CDOs). In 1990, MBIA hadn 't guaranteed a single structured finance product, but by the end of 2008 it had over $200 billion of exposure, equal to 25.8 percent of its total insured portfolio.

Any time a company materially changes its business, there is a significant chance of something going wrong because of execution risk, unfamiliarity with the new lines of business, and so forth. The potential downside should any of these risks materialize is, of course, magnified dramatically in the case of a highly leveraged financial institution like MBIA. As MBIA has discovered, there are vast differences between municipal bonds and structured finance products. The domestic public finance business has been around for a long time, so it can be modeled with a reasonable degree of accuracy, and MBIA successfully participated in the market for decades. In marked contrast, the structured finance products Wall Street was peddling during the housing bubble were relatively recent creations with risks that were unknown to MBIA (and, as we now know, to the rating agencies who misrated them, the banks that sold them, the regulators that failed to regulate them, and the institutional investors that bought them).

MBIA is a classic story of a company stretching to continue its long-accustomed growth by getting into areas it had no business being in—and the company and its shareholders have paid a terrible price. As the housing bubble burst and the credit crunch hit with full force, MBIA suffered blow after blow, including multiple rating downgrades and losses that crushed book value per share from $53.43 at the end of 2006 to $4.78 only two years later.

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Real Estate 101

Real Estate 101

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