Posted by: Aaron Pressman on February 12, 2008
Warren Buffett’s offer to take over insurance coverage of $800 billion of muni bonds from the troubled “big three” insurers is no rescue plan for them — it’s a death knell. Any insurer that accepted this offer would have little left but some cash from Warren and a box of rocks. Of course, better alternatives to ward off Buffett’s reinsurance plan are shrinking fast. Those that reject his offer might wake to find the metaphorical horse’s head in their beds a few weeks down the road.
Recall that the three bond insurers, MBIA (Symbol: MBI), Ambac Financial Group (ABK) and Financial Guaranty Insurance Co., spent years as highly profitable but sleepy outfits lending their triple-A ratings to municipalities for a small fee. Munis rarely defaulted, the insurance made it easier for big investors to shop amongst the many diverse issuers and the issuers saved alittle on their interest costs. Win, win, win.
To goose their growth, however, the big three ventured into murkier areas of finance like structured debt and derivatives. Defaults on those deals are now sky high, investors are holding insurance-backed securities trading like the insurance is worthless and almost the whole mortgage market is in chaos. Lose, lose, lose. The major Wall Street banks and brokers, holding billions in debt insured by the big three, would face substantial losses if the insurance is vaporized. The municipal market has also suffered from the uncertainty but to a lesser degree since the underlying bonds backed by the insurers are sound, not something you can say for all the subprime mortgage-backed securities and collateralized debt obligations supported by insurance.
So what Buffett is in essence offering is to take away the safest, steadiest and most profitable pieces of the big three’s portfolios and leave them with the toxic waste. A bit of capital would be freed up but a huge amount of future profits would shift over to Mister Buffett’s coffers. In return for a modest boost to stability in the municipal market, Buffett’s plan appears to pull the rug out from under the insurers and what’s left of the structured finance market. Ouch. One of the three, not named, has already turned the offer down. You can see why but in a few more weeks they may have no choice to but to take an offer they can’t refuse.