The Next Worry: Bond Insurers

Wall Street is fretting that the subprime carnage could spread to bond insurance firms. A key concern is CDO exposure

An exotic form of bond insurance could be the next hidden hazard to blow up in the global credit minefield. An obscure company called ACA Capital might spark the explosion.

The carnage on Wall Street has already been brutal. On Oct. 30, Merrill Lynch (MER) ousted CEO Stanley O'Neal after the bank took an $8.4 billion hit, largely from securities backed by risky home loans. The same day, UBS (UBS) cut earnings by $3.6 billion. Citigroup (C), which has suffered its own $1.6 billion wound, may face a fresh billion-dollar disaster.

Now the crisis is spreading from Wall Street—which has taken $35 billion in subprime-related write-downs and lost more than $220 billion in stock value—to a less well known corner of the financial world, that of the bond insurers. These firms sell insurance to banks and other major investors for bonds backed by mortgages and the complicated investments that hold the bonds, known as collateralized debt obligations (CDOs). The policies are designed to protect investors in case the securities default.

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