We are late to the big news du jour, namely Warren Buffett’s proposal to rescue the muni bond business of MBIA and Ambac. The market staged a peppy rally on the announcement, no doubt due to a resumption of bullish optimism and a lack of understanding of the implications of the deal (the brush-off of AIG’s announcement of a considerably-larger-than-expected loss yesterday of nearly $5 billion due to “faulty accounting,” and the admission that the big insurer didn’t have a handle on the value of some risks, was another sign of change in sentiment).
While we has said before that Buffet would not take a stake in MBIA and Ambac, we did say he and other insurers might be interested in reinsuring or acquiring the muni bond portfolio. While there have recently been stories about the troubles municipalities are now facing due to the doubts about the bond guarantors’ future, those risks are not the cause of the monolines’ woes. The downgrade risk results from their participation in insuring CDOs, subprime debt, commercial real estate debt, and (at MBIA) certain below investment grade debt.
Picking off the best assets does nothing to address the fundamental problem; in fact, it makes the future (assuming there is one) for the monolines worse, since what they will be left with is clearly dreck.
Moreover, if I read the proposal correctly (the details are sketchy), Buffett proposed to take $9 billion in fees from the two bond insurers and put up $5 billion to capitalize the risks assumed. That looks like a negative net investment to me. He would also increase the insurance premiums charged to municipalities to 1.5 times their current level.
Even if you didn’t have the concern about what this deal does to the balance of the monolines’ risks, this looks like an awfully one-sided transaction. Which is what you’d expect, with AIG suddenly looking a bit wobbly and Buffett the only game in town.
Remember that Buffett made a lowball offer for LTCM during its crisis that was also rejected.
Billionaire investor Warren Buffett said he offered to shore up $800 billion of municipal bonds guaranteed by troubled MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. in a bid to gain 33 percent of the debt insurance market.
Buffett’s Omaha, Nebraska-based Berkshire Hathaway Inc. would assume the risk of the debt from MBIA and Ambac in exchange for charging a fee of $4.5 billion each, according to a letter to MBIA’s advisers that was obtained by Bloomberg News and confirmed by Berkshire Hathaway spokeswoman Jackie Wilson.
The offer drove U.S. stocks higher on optimism the plan would help calm credit markets and prevent a slump in the value of municipal debt. MBIA and Ambac dropped on concern Buffett’s proposal would leave them with mortgage securities that caused more than $5 billion of losses last quarter, while Berkshire would gain a municipal guaranty business that has generated profit for more than 14 years.
“He is offering to take the fattest, most profitable part of their business,” said Jerry Bruni, president and portfolio manager, at J.V. Bruni and Co. in Colorado Springs, Colorado. Bruni has $650 million under management including Berkshire shares. The firm sold MBIA last month. “I can’t imagine why they would want to do that. If I were MBIA or Ambac, this does not sound like a good offer.”
The offer excludes the bond insurers’ subprime-related obligations, Buffett told CNBC during an interview earlier today. One company has already rebuffed the proposal and the two others haven’t responded, Buffett said.
Berkshire would put up $5 billion as capital for the plan and is offering to insure the municipal debt for 1.5 times the premium charged by the bond insurers to take on the guarantee. The insurers could accept the offer and back out within 30 days for a fee, Buffett said.