The hits just keep coming for struggling bond insurers. Dennis Herrera, City Attorney of San Francisco, filed suit yesterday to accuse 5 bond companies of selling worthless insurance policies to California municipalities. The lawsuit, which names Ambac Financial Group (ABK: sentiment, chart, options), MBIA Inc. (MBI: sentiment, chart, options) , Financial Guaranty Insurance Co., CIFG North America Inc., and XL Capital Assurance (XL: sentiment, chart, options), alleges that the bond insurers failed to disclose to the cities that they insured billions of dollars' worth of high-risk mortgage debt. Similar litigation has already been filed by the cities of Los Angeles, Oakland, and Stockton, California.

Herrera also charges that the 5 companies named conspired with credit agencies to charge higher premiums to cities. He asserted, "Since corporations borrowing billions of dollars aren't required to buy bond insurance to get the lowest interest rates possible, the bond insurers have conspired to maintain that dual rating system because they knew it was the backbone of their entire industry."

The news has been devastating for bond-insurance stocks today. ABK is down more than 15%, MBI has tumbled nearly 16%, and XL fell more than 35% to touch a new annual low of $5.52.