) -- It's easy to forget that, as we record the one-year anniversary of

Lehman Brothers'

failure, the writing had been on the wall since January 2008.

After all, credit default swap prices of

Ambac Financial Group




(MBI) - Get Report

indicated the standard-bearer bond insurers had more than a 70% chance of failing.

Lehman, the largest mortgage bond underwriter, was forced to start buying credit default swaps to hedge against the bankruptcy of bond guarantee insurers, and, as a result, credit default swap prices rose dramatically. Shares of Ambac and MBIA plummeted. This past January was a hellish nightmare for Ambac and MBIA. Their stocks were down 93% and 88%, respectively, in 12 months.

Ambac and MBIA went on the defensive. Ambac decided not to raise additional capital to protect its rating, lost its chief executive officer -- and had its ratings downgraded anyway. MBIA resisted, but eventually succumbed, to a ratings cut. There's no market for insurance from bond insurers without AAA ratings because the point is that an insurer guarantees the bond, thus reducing the cost of borrowing to the issuer.

Throughout the ordeal, MBIA remained publicly baffled by rating-agency actions, clearly unable to see that January 2008 hosted the appetizer for the upcoming Lehman and

American International Group

(AIG) - Get Report

entree. By the end of the summer, the markets were poisoned, and there was no way to stop the inevitable.

But the patient survived. If the stock market is recovering and the credit market thawing, the living hell for bond insurers continues. Ambac abandoned its efforts to set up a ring-fenced business to start offering new bond insurance from January 2010 when it became clear that there was no new capital available.

If Ambac had gone ahead and raised additional capital in January 2008, it would have all been for nothing. Companies were no longer in control of their own destiny. Ambac's stock fell from $63 in September 2007 to $6 in mid-January 2008.

The price remained depressed through the remainder of the year until September. The markets crashed, Ambac's stock followed -- down to 76 cents. It reached its low March 9, 2009, at 35 cents. Although the stock is up 25% this year, it's fallen 77% from a year ago.

MBIA raised $500 million in additional capital during January 2008, but that amount wasn't considered sufficient to cover the increase in projected losses for the year. Priced at around $58 in September 2007, MBIA's stock had fallen to $8.55 by mid-January 2008. Unlike Ambac's, MBIA's shares continued to drop through the summer as it became clear that its ratings, once lowered, wouldn't soon be regained.

MBIA's shares were more resistant than Ambac's, though they eventually succumbed and tumbled to $2.17 on March 5, 2009. The company's stock has risen 59% this year, but is down by more than half from a year ago.

MBIA is facing lawsuits from a number of banks, including

Bank of America

(BAC) - Get Report



(JPM) - Get Report

, after New York's former insurance regulator, Eric Dinallo, allowed the company to separate the municipal bond business from its other operations. That action weakens the ability of the insurer to meet its obligations by removing around $5 billion in capital.

When all is said and done, MBIA has a cheap price-to-book value of only 48%. It could make some money this year, but faces questions about the legality of the split. Short interest is growing, and the company has a beta of 1.66, so with this volatility will come opportunity, even as the SNL Financial analyst consensus target price of $5.25 has been exceeded and there is no dividend.

Ambac, on the other hand, will lose money this year. Again, there is no dividend for investors, and, with a consensus analyst price target of $1, the stock is overpriced. It also has a beta of 1.66, but what gain is there for a company that's no longer writing insurance.

Through the release of $1.8 billion in reserves at the end of June, Ambac reported in August that it wasn't in breach of any capital requirements. Liquidity dropped from $178 million to $164 million in the second quarter, but Ambac reports that this represents 1.8 times the annual debt service requirement. Nevertheless, there is ample cause to be concerned about the long-term health of Ambac.

Both MBIA and Ambac are considered "sell" by, and, although the decline started early for these companies, well before the market, a recovery is a long way off, if ever. That isn't good news for the future of municipal bonds, but if an AAA-rated insurer can step up, the market is wide open.

Reported by Gavin Magor in Jupiter, Fla.

Gavin Magor joined Ratings in 2008, and is the senior analyst responsible for assigning financial strength ratings to health insurers and supporting other health care-related consumer products, including Medicare supplement insurance, long-term care insurance and elder care information. He conducts industry analysis in these areas. He has more than 20 years' international experience in credit risk management, commercial lending and analysis, working in the U.K., Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.