This is a Really Stupid Idea

From the WSJ:

The banks are trying to figure out how to commute, or unwind, their credit default swaps, which are contracts they entered into with FGIC and other bond insurers to guarantee their portfolios of complex debt securities known as collateralized-debt obligations, or CDOs, according to people familiar with the talks.

A consortium of banks working toward a rescue plan for bond-insurer Ambac Financial Group Inc. also is discussing a similar option, according to people familiar with the matter.

In exchange for unwinding the contracts, FGIC and Ambac could give the banks stakes in their companies through warrants, according to these people.

Let me get this straight.

The companies that issue debt would then partially own the company that guarantees the payments of that debt? Am I the only one who sees a mammoth conflict of interest issue here?

Let's play this one out.

Company X issues $100 million in bonds backed by questionable collateral (I don't know -- let's say it's backed by a pool of questionable home equity loans).

Company X would really like to get some cheap insurance for these bonds to get a better rating from the rating agencies -- and increase quarterly profit.

Enter the guarantor the issuer partially owns. For some reason the issuer gets a really good deal on bond insurance.

The ratings agencies disclose this relation,, but in very small print on page 94,892 of a nearly incomprehensible analysis of the bonds. Oh yeah -- the ratings agencies also issue a disclosure/warning with that report that still basically says "buyer beware".

Collateral goes belly up (I know that would never happen because the issuer would use stringent underwriting standards too prevent it from happening). But let's say it goes belly up anyway -- just for the sake of argument.

Insurer gets hit with a bill they can't pay. But who cares? The issuer -- who partially owns the insurer -- got a great deal on bond insurance which lowered their compliance and issuance costs and increased their profit for a quarter. The insurer goes belly up or takes a major hit to its earnings, but upper-level management still gets a sweetheart post-dismissal compensation package (or they have been dumping stock for the last 6 months because they see the writing on the wall).

Let's just repeat the problems we've had for the last 6 months - 9 months again, shall we? They have been so much fun the first time around after all.