NEW YORK -- Even as stocks ended five days of losses with a surprising recovery yesterday, officials began moving to defuse another potential time bomb in the markets: the weakened condition of two large insurance companies that have guaranteed buyers against losses on more than $1 trillion of bonds.
Regulators fear that, in a worst-case scenario, the troubled bond insurers, MBIA Inc. and Ambac Financial Group Inc., might be unable keep their promise to pay investors if borrowers default on their debt.
That could leave the buyers of the bonds - including many banks and pension funds - on the hook for untold billions of dollars in losses, shaking confidence in the financial system.
To avoid a possible meltdown, insurance regulators met with representatives of about a dozen banks yesterday to discuss ways to shore up the insurers by injecting fresh capital, much as Wall Street firms have turned to outside investors recently after suffering steep losses related to subprime mortgages.
While it was unclear what steps, if any, the banks and regulators might take, the talks focused on raising as much as $15 billion for the companies, according to several people briefed on the discussion.
A growing concern about the financial condition of bond insurers has unnerved Wall Street and was a factor in the Federal Reserve's decision Tuesday to calm investors by sharply reducing interest rates by three-quarters of a point, to 3.5 percent.
News of yesterday's meeting helped rally stocks. Shares of MBIA rose nearly a third and Ambac soared 72 percent, although both remain far below their levels before the extent of the mortgage debacle became known.
Traditionally, bond insurance has been a low-risk business. State and municipal bonds rarely defaulted, so the insurers paid out few claims for such debt. But in recent years the bond insurers increasingly have guaranteed debt related to subprime mortgages, a business that they thought was safe but has turned out to be risky.
Now, as many subprime borrowers are defaulting, insurers could be obligated to cover some of the losses on securities backed by these loans.
Eric R. Dinallo, the New York insurance superintendent who regulates MBIA, called Wall Street executives Tuesday to set up the meeting at his office in Manhattan. He led the session yesterday and suggested that the group move in as little as 48 hours to get a deal done ahead of any downgrade of the bond guarantors by credit ratings firms.
"Regulators are furiously trying to come up with a plan," said Rob Haines, an analyst at CreditSights, a research firm.