The bond insurance crisis has emerged as a key challenge for the regulators and policy makers, who are trying to fend off the mess right away before it sends the whole financial system into disarray.

After the subprime mortgage collapse and the global credit crunch, the bond insurance crisis-a new quandary that could be just the warning of another financial fiasco-has started deepening. Leading bond insurers like MBIA, Ambac Financial and FGIC, which are popularly known as `monolines', are altogether a key cause of concern for Wall Street since their credit ratings came under increasing pressure due to their involvement with risky mortgage-backed securities that have lost value. Bond insurers focused exclusively on standing behind municipal bonds for many years. They were engulfed by present crisis when they entered into the world of structured finance and complicated credit derivatives. It is now clearly noticeable that the battered bond insurers will face a severe capital deficit. As per Moody's Investor Service, about half of municipal bonds are supported by insurance, of which 563,000 individual ratings are under debt downgrades.

Even though Ambac and MBIA-the two most troubled monolines-retain top-notch credit ratings, doubts have been raised about their municipal guarantees. Both are on the verge of a critical situation. Rating agencies like Moody's Investors Service and Standard & Poor's have warned that they would strip them of their top-notch `AAA' ratings. Credit Default Swaps (CDSs) on the debt of MBIA and Ambac indicate that the companies will default in the next five years. In the last week of January, Ambac posted a quarterly loss of $3.3 bn, just a few days after Fitch Ratings downgraded its triple-A status. Several bond insurers are experiencing rating downgrades and potential collapse because of their undermined capital position. However, such downgrades would be a great threat not only to the insurers' municipal and corporate debt insurance business, but also to the stability of the entire financial system.

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