Legal

New York's top financial regulator, Benjamin Lawsky of the Department of Financial Services, deserves kudos for orchestrating a blockbuster settlement between Morgan Stanley and the bond insurer MBIA. Morgan Stanley was one of the leading members of the coalition of banks challenging MBIA's 2009 restructuring, so its withdrawal from the litigation -- which reduces the number of remaining banks in the case to five -- is a boon to MBIA. According to Morgan Stanley's announcement of the settlement, the bank is taking a pre-tax loss of $1.8 billion on the deal, which also resolves Morgan Stanley's claims for billions in outstanding credit-default swap protection from MBIA, as well as MBIA's mortgage-backed securities claims against Morgan Stanley. (This Reuters story by Lauren Tara LaCapra explains the settlement's benefits for the bank.)

Morgan Stanley didn't mention this in its press release, but I've confirmed what the Wall Street Journal was the first to report: As part of the settlement, MBIA is paying Morgan Stanley $1.1 billion in cash. It's the biggest payout the bond insurer has made to a bank in the restructuring challenge, but that's not the only reason the cash aspect of the Morgan Stanley deal is notable. According to a source familiar with the settlement, MBIA Insurance took out a secured loan from MBIA National for the $1.1 billion.

Insurance and National are the two divisions created in the 2009 restructuring, when MBIA split its profitable municipal bond insurance business from its troubled financial products group. Throughout the litigation challenging the restructuring, the banks have insisted that MBIA's diversion of $5 billion to the muni bond business left MBIA Insurance without enough capital to pay policy claims on mortgage-backed securities and other structured finance products it insured. Even as the coalition's numbers dwindled, bank sources told me MBIA would have to tap that $5 billion if it expected to reach deals with the last stalwarts in the restructuring challenge. The terms of the Morgan Stanley settlement suggest that's what MBIA has done.

Bank of America, the remaining coalition member with the biggest claims against MBIA (and, conversely, the remaining coalition member against which MBIA has asserted gigantic MBS claims), declined comment on whether the Morgan Stanley settlement portends an end to the messy litigation between BofA and MBIA. An MBIA spokesman declined any comment on the Morgan Stanley deal. The bank coalition's counsel, Robert Giuffra Jr. of Sullivan & Cromwell, said in an email statement, "The remaining plaintiff policyholders will continue to fight to restore the billions fraudulently taken from MBIA Insurance."

MBIA policyholders, however, were quick to interpret the Morgan Stanley deal as an acknowledgment that MBIA Insurance is undercapitalized. "The reported settlement shows that MBIA Insurance has insufficient assets to pay policyholder claims. That's what we've been saying all along," said David Ichel of Simpson Thacher & Bartlett. Ichel is representing the hedge fund Aurelius as lead plaintiff in a policyholder class action against MBIA. Aurelius alone holds hundreds of millions of dollars in MBIA policies, Ichel said, and MBIA's obligations to the class as a whole total hundreds of billions of dollars.

Ichel said that he, like members of the bank coalition, has met with Lawsky, the N.Y. financial regulator, to discuss an MBIA settlement. (Unlike the banks, which brought both a damages case against MBIA and a regulatory action that also named the state insurance department, the policyholders haven't sued the state.) "We're hoping he resolves everything," said Ichel. "If he doesn't, he's going to have a failed insurer to deal with."

(Reporting by Alison Frankel)