Buffett’s offer sounded too good to be true at first hear and now looks increasingly so, how exactly would his offer work . Incidentally, wouldn’t he just be taking over the muni business and leaving the toxins to be buried with the monoliners?

Talk about an offer you cannot not refuse.

Consider eating at McDonald’s: you don’t want to individually research the quality of each hamburger before you bite into it, no matter how slight the risk of an unpleasant surprise. You just want a guaranteed-to-be uniform product.

Another point is that S&P and Moody’s charge a large fee for issuing a rating on a muni bond, and sometimes it can actually be cheaper for the issuer to get insurance than to get the underlying bond rating.

Yes he’s setting up his own rival company, but it will take him a long time to build up new revenue streams equivalent to the existing ones. He could tap into those revenue streams right away if he made an offer the incumbents could live with.

Maybe he’s just charging what the market will bear (the current rate that the market already pays plus a hefty premium for Berkshire’s genuine AAA), figuring that Ambac and MBIA will soon be history and he’ll have the field all to himself, so why not establish premium pricing right from the start?

But an alternative idea is that he’s charging a higher, possibly uncompetitive rate because he’s actually calculated the risk and it’s higher than expected. Could there be some black swan events that could lead to a large number of correlated muni defaults (severe economic depression, earthquake, epidemic, WMD event)? Or are such events excluded from coverage?

When Bill Gross mockingly notes that tiny Ambac can’t insure the state of California, implicit in that is the notion that there does exist the possibility of rare but huge losses, otherwise why would you even care if a bond insurer was undercapitalized? So muni bond insurance is perhaps not so superfluous after all.

The only reason for mentioning LTCM was that then too Buffett made a very lowball offer to salvage an operation that had the potential to create systemic risk.

Anon of 6:25 AM,

What Buffet said about “freeing up capital” is true only in a narrow technical sense; in any practical sense, it’s utter hogwash.

First, MBIA and Ambac would EACH have to pay Buffett $4.5 billion for him to takes these risks. That’s more than Ambac has in equity and more than half of MBIA’s equity. And this is for their best risks.

Every bit of research ever done says that muni bond insurance is a ripoff to municipalities. The rating agencies incorrectly grade them much tougher than corporate credits. I don’t have the stats ready at hand, but the disparity is large, something on the order of an single A muni credit has the same default risk as an AAA- corporate credit.

So rather than perpetuating this sham, it would be better if the powers that be went on a massive education campaign. There are TONS of third party sources that could be cited. There might be some lower credit quality municipalities that would benefit from insurance, and perhaps ones where the deals are so small that the cost of paying to get rated is higher than the cost of insurance. But those should be a subset of the universe being insured now.

Brian,

Your point that this proposal may force how to deal with long-tail liabilities is a good one, and yes, I suspect Dinallo can make MBIA’s life pretty unpleasant.

The problem is that when the rescue operation was first conceived, the objective was to prevent downgrades because it would lead to forced sales of CDOs and other structured finance paper by entities that were restricted to holding instruments with a certain rating. That would lead to that paper trading at low prices which in turn would force more writedowns by Wall Street firms. It might also lead to defaults on credit default swaps, which again would lead to writedowns.

Thus, the motivation was to prevent further hemorrhaging of balance sheets. The Buffett proposal saves munis, the new hot problem, at the expense of greater damage to the banking industry and Wall Street by leaving even less capital available to cover the structured finance risks. A simple runoff is the probably the best of the bad options available.

I think we are closure to regulatory intervention than you suspect. I detect the hand of Dinallo in this announcement by Buffett.

Consider the world from Dinallo’s (or Wisconsin regulator’s) perspective. You have the sword of Damocles (rating agencies) hanging over the heads of these insurers. If they get downgraded they are not coming back to AAA any time soon. The auction rate muni market is a turning into a 100 car pileup which has major implications for the parties that I think he cares most about, S&L govts and the mom and pop punters out there with muni portfolios. Ambac has thumbed its nose at the rating agencies on raising capital, at least for the moment. The banks are at the table with great reluctance trying to do a deal that would be hard to arrange even in the best of circumstances. Time is running short and you could see the whole thing unravel pretty quickly.

The Buffett offer defines a sort of worst case alternative for the parties at the table (at least for the monoline mgmt and their shareholders). If Dinallo’s first concern is with saving the muni market from mortgage contagion (which I suspect it is), this is a pretty good worst case solution – putting the safety of the muni market in the hands of Buffett. He now has a lever to go back to the table with and can credibly threaten the parties at the table that he can impose a solution that is worse than what they might hatch on their own.

I don’t know all the particulars of the insurance statute and perhaps Dinallo doesn’t hold as many cards as I think he does, but I’m guessing that he can make life pretty difficult for them if he wants. Certainly an announcement by Dinallo that “in view of the stresses in the structured credit portfolio and the need to insure sufficient capital to meet any long tailed claims in the muni portfolio, we are hereby prohibiting the payment of any dividends to the holding company” would not seem out of bounds to anyone who has studied the monolines’ plight. The monolines would certainly piss and moan about this, but there are lot of people who think it should have been done already, statutory accounting notwithstanding. Even if they fight it in court and win, Dinallo will have made his point to the market, forcefully, that they need to find a financing solution.

Moreover, I suspect by now that Dinallo and the others who have studied the structured finance liabilities know that keeping the monolines at AAA is a hopeless cause and the best outcome is to have somekind of soft landing in a run off mode where you can keep the rating at a level that minimizes the damage to the banks. The bank write offs in the absence of a deal would be painful, but probably not fatal for the banks in the US (Europe might be a different story). If Dinallo had to sacrifice a solution for the banks’ problem in exchange for keeping the muni market functioning I think he would make that trade. That does not answer the question of where the incremental new issue underwriting capacity would come from, but I suspect the answer is that FSA, AGO and Berkshire would raise more capital and fill in the capacity (and more issuers would go without insurance as well)

Buffett (Jain actually) said in his letter conveying his offer to MBIA that BHAC conferred with Dinallo before extending the offer to MBIA, and I find it hard to believe he would have gone public with this, given how difficult the negotiations to find a solution must be, without bouncing it off Dinallo first or, as likely in my view, at Dinallo’s suggestion.

Brian

>> This is becoming an interest to me, because I feel this entire financial mess is the result of the abuse of discretionary powers, which if one follows the tangent, can be traced back to abuses by local governments, i.e, perhaps our best model is The LGIP in Florida, which as you may recall, is related to discretionary abuse of power.

Following this tangent further, we may need to go back to either 9/11 or The Bush Homeownership Society, which he brought up in his second inaugural address/dictum.

I am not sure if this matter began with a Federal objective to dilute Iraq war debt into a an offsetting housing bubble/boom, i.e, The Fed promoted ownership and encouraged illegal aliens to become a part of building boom, underwritten by cheap global liquidity products; the bubble was enhanced by the stupidity of Greenspan and the web of collusion efforts which are related to the fact that every regulator, supervisor and person of accountable authority in America looked the other way and abused the discretionary powers they had. Greenspan mildly suggested that the housing market might be a little frothy, when infact almost every home in America had doubled in appraised value — which mortgage people bought into, bankers, county treasurers, obviously any realtor, every lawyer, ever state and fed official, and every bond underwriter and every bond insurer!

As a further example of this, the community I live in is small, and back in 2001, we had the unfortunate problem of a walmart superstore that just had to be built no matter what, and although the town did not want that business to be built, the local government pushed the agenda and ignored the impacts to our community, because it seemed at the time, that there was a very STRONG Republicn political party that wanted to help push The Bush Ownership Society, no matter what, because these fascist minded people wanted to push a dogmatic agenda, which included pumping the housing bubble!

The housing bubble was connected to the very same dogmatic fascist exploitation in the colorful world of synthetic derivatives, where these crooks ran wild and spun out packages and pools of unregulated toxic poison and polluted the world with corrupt and bogus securities that were blessed by every rating agency — agencies that once again, were able to abuse discretionary powers and to be unregulated, and unaccountable for any of their actions.

And, now, someone like you wants to cry about the local governments or the failure of bonds that should never have been underwritten in the first place! You seem to think, these abusive people that were out of control need additional life lines and safety nets to save them from the casino chaos that they built brick by brick, in a collusive effort to abuse the people that they swore to protect! Screw them for the abuse and damage they have caused and I pray to God, that local taxpayers place these corrupted bastards under the highest power Laser Scanning Confocal Microscopes and expose the fraud these people spun out, in a mindless effort to sprawl endless expansion that was not wanted or needed. I also hope, local populations as a collective force seek tax holidays and find ways to avoid property taxes associated with this homebuilding bubble, and then, maybe these local governments will shut down the developers and start looking at how to manage the messes they created!

Warren Buffett’s Wild Ride at Salomon
October 27, 1997 

Warren Buffett’s Wild Ride at Salomon A harrowing, bizarre tale of misdeeds and mistakes that pushed Salomon to the brink and produced the “most important day” in Warren Buffett’s life.

http://chinese-school.netfirms.com/Warren-Buffett-Salomon.html

So on that Thursday, Salomon began to experience a run. It materialized out of left field in the form of investors who wished to sell this big-league trader and market maker, Salomon, its own debt securities–specifically, the medium-term notes that the company had outstanding. Salomon had always made a market in these securities, but that was ordinarily a yawn, since nobody wanted to sell. But now the sellers poured in. Salomon’s traders responded by lowering their bids, trying to deter the traffic–dying to do that, in fact, because every repurchase of notes they made melted down the capital base that was holding up the whole Salomon structure. Finally, after the traders had bought about $700 million of the notes, Salomon did the unthinkable: It stopped trading in its own securities. That called a halt on the rest of the Street too. If Salomon wasn’t going to buy its own paper, it’s for sure nobody else would.

** The one who reported the wrongdoing of its employee to Gutfreud, the CEO, was no other than John Meriwether, the legendary top manager of Long Term Capital Management (LTCM), which was again saved from imminent bankruptcy by the Fed effort in 1997 for nearly identical reasons.

II feel the following summation is worth looking at. It is also worth noting that we seem to have a much larger group of collusive idiots involved this time around, and obviously the regulation-people failed 100% with LTCM and Enron and within just a few years after The Bogus Sarbanes-Oxley Act and The Patriot Act, we have more collusion and corruption!!

But First (Dont take my word for it): Fears of a global slowdown triggered by US housing market woes wiped $5.2 trillion (£2.7 trillion) off global stock markets in January, say analysts.

http://news.bbc.co.uk/1/hi/business/7239506.stm

According to ratings firm Standard and Poor’s, 50 out of 52 share indexes around the world ended the month lower.

>>>>Now On To The Lesson:

LESSONS FROM THE COLLAPSE OF HEDGE FUND, LONG-TERM
CAPITAL MANAGEMENT
By David Shirreff

http://elsa.berkeley.edu/users/webfac/craine/e137_f03/137lessons.pdf

In the first two weeks after the bail-out, LTCM continued to lose value,
particularly on its dollar/yen trades, according to press reports which put the loss at
$200 million to $300 million. There were more attempts to sell the portfolio to a
single buyer. According to press reports the new LTCM shareholders had further talks
with Buffett, and with Saudi prince Alwaleed bin talal bin Abdelaziz. But there was
no sale. By mid-December, 1998 the fund was reporting a profit of $400 million, net
of fees to LTCM partners and staff.
In early February, 1999 there were press reports of divisions between banks in
the bailout consortium, some wishing to get their money out by the end of the year,
others happy to “stay for the ride” of at least three years. There was also a dispute
about how much Chase was charging for a funding facility to LTCM. Within six
months there were reports that Meriwether and some of his team wanted to buy out
the banks, with a little help from their friend Jon Corzine, who was due to leave
Goldman Sachs after its flotation in May, 1999.
By June 30, 1999 the fund was up 14.1%, net of fees, from last September.
Meriwether’s plan approved by the consortium, was apparently to redeem the fund,
now valued at around $4.7 billion, and to start another fund concentrating on buyouts
and mortgages. On July 6, 1999, LTCM repaid $300 million to its original investors
who had a residual stake in the fund of around 9%. It also paid out $1 billion to the 14
consortium members. It seemed Meriwether was bouncing back.

Despite the presence of Nobel laureates closely identified with option theory it
seems LTCM relied too much on theoretical market-risk models and not enough on
stress-testing, gap risk and liquidity risk. There was an assumption that the portfolio
was sufficiently diversified across world markets to produce low correlation. But in
most markets LTCM was replicating basically the same credit spread trade. In August
and September 1998 credit spreads widened in practically every market at the same
time.

A working group on highly leveraged institutions set up by the Basle
Committee on Banking Supervision reported its findings in January, 1999 drawing
many lessons from the LTCM case. It criticized the banks for building up such
exposures to such an opaque institution.

Supervisors themselves showed a certain blinkered view when it came to
banks’ and securities firms’ relationships with hedge funds, and a huge fund like
LTCM in particular. The US Securities & Exchange Commission (SEC) appears to
assess the risk run by individual broker dealers, without having enough regard for
what is happening in the sector as a whole, or in the firms’ unregulated subsidiaries.

The sad truth revealed by this testimony is that the SEC and the NYSE were
concerned only with the risk ratios of their registered firms and were ignorant and
unconcerned, as were the firms themselves, about the market’s aggregate exposure to
LTCM

t is possible to argue that a market solution was found. Fourteen banks put up
their own money, regarding it as a medium-term investment from which they
expected to make a profit. From a value-preservation point of view it was an
enlightened solution, even if it did seem to reward those whose recklessness had
created the problem.
Federal Reserve chairman Alan Greenspan defended the Fed’s action at the
October 1 hearing in the House Committee on Banking and Financial Services as
follows: “This agreement [by the rescuing banks] was not a government bailout, in
that Federal Reserve funds were neither provided nor ever even suggested.
Agreements were not forced upon unwilling market participants. Credits and
counterparties calculated that LTCM and, accordingly, their claims, would be worth
more over time if the liquidation of LTCM’s portfolio was orderly as opposed to being
subject to a fire sale. And with markets currently volatile and investors skittish,
putting a special premium on the timely resoluton of LTCM’s problems seemed
entirely appropriate as a matter of public policy.”
The true test of moral hazard is whether the Fed would be expected to
intervene in the same way next time. Greenspan pointed to a unique set of
circumstances which made an LTCM solution particularly pressing. It seems
questionable whether the Fed would act as broker for another fund bailout unless
there were also such wide systemic uncertainties.

Bruce Jacobs, who has followed the systemic implications of
the 1929, 1987 and subsequent mini-crashes, fearful of the dangers of globally traded
derivatives, writes in a new book: “Had LTC not been bailed out, the immediate
liquidation of its highly leveraged bond, equity, and derivatives positions may have
had effects, particularly on the bond market, rivaling the effects on the equity market
of the forced liquidations of insured stocks in 1987 and margined stocks in 1929.
Given the links between LTC and investment and commercial banks, and between its
positions in different asset markets and different countries’ markets, the systemic risk
much talked about in connection with the growth of derivatives markets may have
become a reality.”