Warren Buffet = ambulance chaser.
Yes, it’s a little unbecoming for Warren Buffet, the Oracle of Omaha, to be chasing around ailing bond insurers with $5 billion in cash, offering ready money for safe assets. But hey, sometimes that’s what a good trade is about. If you can buy assets or earnings at a discount, it doesn’t really matter if it looks like you’re kicking a whipped dog. It’s about money.
So has Warren Buffett become an altruist, offering us all a way out of the credit crunch? Hardly. He’s showing up at a house on fire and offered to save the most valuable goods, but only if he gets to keep them. The bond insurers, at least one of them, have already turned down his offer.
You can’t blame Warren Buffett for trying. He knows the trouble with the bond insurers must reach resolution sometime soon, either in insolvency for the companies or the sale of their assets to billionaire bargain hunters.
The credit ratings of the bond insurers are probably on borrowed time. Why? Well, bond insurance used to be a safe gig. MBIA, Ambac, and FGIC used to keep it simple. They insured mostly municipal bonds issued by state and local governments, for a fee.
State and municipal governments are not “for profit” businesses. They collect their revenues from tax payers with the threat of imprisonment if you refuse to pay. While not so bullish for tax payers who are unhappy with the quality of service delivered by state and local governments, the bonds, from an investor’s perspective are doubly safe.
First, the stream of income and interest is secure because it comes from a government that can simply raise taxes and has the power to coerce “revenues” out of its citizens. Second, the bond insurers have guaranteed the bonds, which gives the bonds the highest possible credit rating (AAA) from the aforementioned ratings agencies.
Then came structured finance and collateralized debt obligations (CDOs). Lured by easy profits, the bond insurers branched out from safe municipal bonds and started guaranteeing new kinds of securities, mortgage-backed bonds, securitized credit card receivables, and more.
According to Bloomberg, the top four bond insurers have guaranteed about US$2.4 trillion in bonds. Somewhere between $800 billion and $1.1 trillion of those bonds were issued by state and local governments, the old conservative bonds least likely to default and cause a bond insurer to dip into its capital to pay up.
You don’t have to have won a Field’s Medal (a prize for brilliant mathematicians) to do the maths. The bond insurers have guaranteed about $1.3 trillion in “other” bonds. Not all of these bonds are at risk, of course. But enough of them are to cause the ratings agencies to raise serious doubts about the solvency of the bond insurers in the not-so-distant future.
The top four bond insurers have about $20 billion in working capital, combined. They guarantee, let’s remind you, over $2.4 trillion in bonds. Do you see the problem here? It doesn’t add up. The idea that $20 billion in capital is adequate to guarantee $2.4 trillion in bonds is laughable. Only no one is laughing.
The Daily Reckoning Australia