At first glance, proposals to separate the bond insurers' toxic sub-prime commitments from their safe municipal bond liabilities appear to miss the point.

Key mortgage bond insurers such as Financial Guaranty and Ambac guarantee the interest and principal payments on securities they underwrite and face billions of dollars in claims as the bottom falls out of the housing market.

As a result, they need a massive capital injection, rather than a massive restructuring, which does nothing to raise more cash.

But the “good-bank/bad-bank” proposal put forward by Eric Dinallo, New York's insurance tsar, has been welcomed since it will safeguard the municipal bond industry.

City and state governments raise about $300 billion (£153 billion) a year by issuing AAA-rated “municipal” bonds, which they use to finance all manner of infrastructure projects.

These low-risk bonds are typically insured and carry the credit rating of the underwriter, which, until recently, has meant AAA.

This top rating is essential because many investors will only hold AAA-rated securities and must automatically sell if the rating drops. Not only does this further depress the value of those bonds, leaving their holders with losses, it also raises the cost of borrowing for local government. Furthermore, the bond insurers' loss of reputation has made it far more difficult to raise municipal debt in recent weeks, threatening lots of infrastructure projects.

By spinning off the insurers' municipal business these new units can recapture the AAA ratings their groups are losing as sub-prime liabilities hit the industry's credibility.

Of course, this doesn't solve the fact that some bond insurers simply don't have enough cash to meet their sub-prime bond liabilities.

But it is an important first step. And since it is in both Wall Street and the Government's interest to limit further losses by keeping the bond insurers afloat, there is every chance the cash will be found from somewhere over the next few days.

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