NEW YORK (Bloomberg) — Ambac Financial Group Inc. and MBIA Inc. shares fell on Friday, along with other bond insurers, as Morgan Stanley said the industry may face a "downward spiral" and Goldman Sachs removed its "buy" rating on the two companies.

Morgan Stanley lowered the financial guarantee industry to "in-line" from "attractive", after Goldman Sachs Group Inc. earlier cut its rating on the two companies to "neutral" from "buy."

The bond insurance industry has guaranteed more than $1 trillion of bonds issued by US cities and states as well as bonds backed by mortgages, credit cards and other assets, and the guarantee allows borrowers to use the insurers' AAA rating. A loss of confidence by investors in the insurers' credit quality threatens the survival of the industry and the price of the thousands of bonds it guarantees.

Ambac, the world's second-largest bond insurer, fell $6.06, or 20 percent, to $23.51 on Friday in New York Stock Exchange Composite trading. On Friday, October 5, the shares closed at $70.11. MBIA, the biggest bond insurer, slid $2.55, or 6.7 percent, to $35.51. Four weeks ago they closed at $67.78.

"As the credit market continues to weaken, our confidence that guarantors will survive the credit meltdown is waning, prompting us to take a more conservative view of the financial guarantors," said Ken Zerbe, an analyst with Morgan Stanley.

Zerbe said a worsening of defaults on mortgage, home equity loans and credit card balances "could prove to be the proverbial straw that starts the downward spiral in the viability of the guarantors' business model."

He increased his expectation for losses on collateralised debt obligations or CDOs, predicting that Ambac could take losses of $2.1 billion and MBIA could take losses of $415 million. When other types of securities were included, particularly those backed by home equity lines of credit, Zerbe said he expected Ambac to lose $3.5 billion and for MBIA to lose $2 billion.

Goldman Sachs analyst James Fotheringham said he was concerned the bond insurers could need to raise cash if more collateralised debt obligations have their ratings cut further.

The report said Goldman recommended investors buy Ambac when analyst coverage began last November 16; since then, Ambac is down 65 percent. Goldman added MBIA to its "buy list" on April 27; the stock has fallen 47 percent in the meantime.

Bond insurers hold capital against the securities they insure and increase the reserves they set aside when credit ratings fall. CDOs are debt securities backed by bonds or other loans, many of which have declined in value as the US housing slump worsened.

Bermuda-based Security Capital Assurance Ltd., a spinoff of Xl Capital, fell $1.42, or 14 percent, to $8.70. The shares are down 39 percent over the last five days and traded at $22.07 on October 5. Bermuda-based Assured Guaranty Ltd. fell $3.23, or 17 percent, to $15.37 and has lost 38 percent in the last five days. Assured Guaranty is a spin off of ACE Ltd.

Other Bermuda-based surety guaranty reinsurers also fell.

Ram Holdings Ltd. was down 38 cents to $5.04. It was trading around $10.50 a month ago, while Primus Guaranty was down 28 cents to $8.58. It closed at 11.28 on October 2.