SocraticGadfly: The truth behind Buffett’s offer to back up bond insurers — and how it could make the recession worse

February 15, 2008

The truth behind Buffett’s offer to back up bond insurers — and how it could make the recession worse

Jon Markman lays out the less than idealistic details.

First, it’s only half a backstop. He’s only willing to reinsure low-risk muni bonds, not higher-risk private sector issues.

Second, it’s even more cynical than I first realized.
You almost have to admire the old buzzard’s devious but brilliant gambit, as it was the equivalent of a rich man walking into the parlor of a family about to lose its home to foreclosure and offering to buy all the good furniture, tapestries and china at pennies on the dollar.

His plan to provide backup insurance for $800 billion in guarantees would briefly shore up the finances of these devastated monoline insurers, to be sure, but it would also leave them with so much exposure to faltering debt instruments that the insurers would remain fully vulnerable to life-threatening downgrades from bond-rating outfits. …

Buffett is essentially asking the prayerful insurers to sell him the one thing they have ever made money on — muni guarantees — and hold on to the junk that no one can value. He is trying to rip out their throats while they’re up against the wall — the high-finance equivalent of a payday loan. He's suggesting they give up the tremendous long-term income stream generated by municipal bond issuers’ insurance payments for enough cash to get through the new next few months. …

The good news about Buffett’s move is that it exposed to the world just how disconnected the equity world is from the credit world. The gesture was greeted with a clueless surge in stock prices, but the debt world recognized the ineffable cynicism embedded in the Omaha, Neb., investor’s gesture and pushed risk spreads wider — their equivalent of a big thumbs down.

Markman also kindly reminds us of the exorbitant rates Buffett charged for terrorism insurance after 9/11.

Markman also notes that Buffett’s offer, which bond insurers have a month to accept, could force local governments to buy back major chunks of their municipal bond offerings.

Already, without this friendly offer from St. Warren, the credit crunch is hitting the muni bond market:
Already this week the world of seemingly low-risk credit got a lot more tense when a large set of bonds sold by municipalities with rates set through periodic auctions failed to attract much interest, requiring deal runners Citigroup and Goldman Sachs to commit their own thinning capital to the deals.

This is something that never happens, and the consequences are grave. Just to give you an idea, Bloomberg reports that rates on $100 million in bonds sold by the Port Authority of New York and New Jersey this week soared to 20 percent from 4.3 percent a week ago. Debt put on the block by Presbyterian Healthcare in Albuquerque, N.M., and New York state’s Metropolitan Transportation Authority met a similar fate, according to the wire service, as investors' confidence in the credit strength of the insurers has plummeted.

Twenty percent for bonds issued by a governmental agency as big as the Port Authority? That’s HUGE.

Clearly, something like the buyback effect of Buffett’s offer would likely have the primary effect of pushing us further into recession. Ambac and other bond insurers have a month to decide whether or not to swallow Buffett’s poison pill.

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