PIMCO: Smart Choice by Insurance Commissioners to Rate Bonds

What's not to like about PIMCO, which was picked by insurance regulators as the arbiter of value for up to $145 billion in residential mortgage backed securities? The National Association of Insurance Commissioners, which represents the state-run insurance system, announced yesterday that Pacific Investment Management Co. had won a runoff with 10 other companies for the assignment.

The NAIC had been uneasy about the 18,000 mortgage securities held by insurers in light of their devaluation during the real estate crisis and recession. But it was even more uneasy about the way the traditional rating agencies - Standard & Poor's, Moody's Investor Service, and Fitch Ratings - were handling them, since these raters did such a poor job. First they blew up the mortgage bubble until it overinflated. Then they punctured it with such a big bang that Congress is now investigating them, mostly for incompetence.

All this made life difficult for the life insurers that bought large amounts of these mortgage-backed holdings at high values to hedge against the day they might have to pay claims. When those long-term investments plunged in 2008, they were left with a shortage of capital.

Regulators keep a close watch on insurers because if the value of their collateral declines these companies have to reserve additional capital to meet their obligation to policyholders. According to the American Council of Life Insurers, that amounted to an additional $11 billion this year alone. This cuts into revenue and, in turn, profits. Insurers, in particular MetLife, demanded that capital requirements be eased.

This hasn't happened yet, but with PIMCO on the job it could ease regulators' and insurers' concerns alike. According to Bloomberg, PIMCO has more than $900 billion of managed assets, much of it in bonds, and has worked with the Federal Reserve to manage its Commercial Paper Funding Facility, which plugs holes in the short-term debt markets.

PIMCO also has "wise old men" like managing director Bill Gross and Chief Executive Mohamed El-Erian who are known for their smart commentary on the bond market.

The ones that didn't fare well from this decision were the three rating agencies, and Blackstone Group, which was mentioned as a contender for the job, but not chosen. Blackstone, whose name is closely aligned with promoting the mortgage-backed market, obviously had the knowledge, but may have been viewed as the cause rather than the cure.

Those who want to see the new process in action can attend the NAIC's "Valuation of Securities Task Force" meeting scheduled for November 30.