February 12, 2008

Bond Insurance

I am sure that you are aware of the bond insurance problems plaguing the debt market. These insurers are leveraged by a magnitude of $100 to $1 of capital and hold insurance contracts on some of the most speculative debt that was once rated AAA.

Today Buffett offered to insure their muni portfolios, see story here. no one should mistake the offer as a bailout, as Buffett, the businessman, is not in the business of bailing out business. Make no mistake Buffett wants to make a pretty penny on this offer and when I say pretty penny it is in the magnitude of more than 400% return.

I have no idea what is the offer but from previous transactions I know he bids very low to the potential value of the asset. For example, he offered to purchase the Long term Capital Management positions in their time of crises in 1998. He offered some $250 million for a portfolio worth $4 billion. Also his offer usually eliminate risks; in the case of LTCM he offered to buy only the assets with no management personnel or the the partnership structure.

In the case of the insurers' offer it does not solve their problem at all. He is offering to insure something that have default rate of less than 1% historically, while leaving the problematic structured debt.
"The muni market is not what's causing the difficulty. It doesn't solve the underlying problems, which is mispriced premiums on the structured finance transactions."

Bond insurers have lost billions of dollars by moving beyond their traditional business of backing muni bonds and insuring risky subprime debt. The losses could result in the insurers losing their coveted triple A debt rating, which is crucial for their business.

In the end I think the offer will fizzle and amount to nothing because no one in their right mind will accept it. I do not think that Buffett will buy any one of them becasue he already established a similar business and in due time will take all their clients. Also, I do not see any private entity will step to buy them as no one will want to compete against the better capitalized Buffett reinsurance. The only solution is a government bailout.


Anonymous said...
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Anonymous said...

I agree that this deal is unlikely to go through. Buffet is sure to have an ulterior motive, which would spell great danger for the insurance bonds market.

Buffet is a powerful man and doesn't really need to buy out all the portfolios to get all the clients at some point in the future.