Buffett's Bond Plan Offers Little to Insurers

I'LL NEVER CEASE to be amazed by Warren Buffett. No, not by his wealth. Not by his investment acumen. And not by his folksy wisdom. I'm amazed at the shameless greed of the man, and the fact that despite it, the media continues to treat him like a saint.

Don't get me wrong. I firmly believe that as Gordon Gekko said, "greed, for lack of a better word, is good." But as I recall the villain of Oliver Stone's movie "Wall Street," Gekko didn't expect people to love him for his predatory ways. I have no idea what Buffett expects, but the world does indeed love him, and he is indeed predatory.

This week Buffett announced he had made a proposal to several of the largest firms in the bond insurance business, companies like Ambac Financial (ABK: 10.22, -0.31, -2.94%) and MBIA (MBI: 12.24, -0.38, -3.01%) that insure principle and interest repayment for municipal bonds as well as exotic mortgage-backed securities. According to the media, Buffett's proposal was designed to "rescue," "bail out" and "save" these companies, which have been hit hard by mortgage-related losses in the subprime crisis.

But if you strip away the hype, the reality of Buffett's proposal was to invite these companies to commit corporate suicide, and pay Buffett billions of dollars for the privilege. Needless to say, the companies have told Buffett to take a hike, and take his proposal with him.

But Buffett doesn't care. He got another news cycle of being portrayed as a selfless, courageous and civic-minded businessman. And if having his vanity stroked like that wasn't enough, he got to publicize his own company that competes with the bond insurers — a brand new company, the media is eager to tell us, without the baggage of poorly performing mortgage-related assets.

Here's the essence of the plan: Buffett proposed to reinsure $800 billion of municipal bonds currently covered by the bond insurance companies. That means that if, for some reason, a company like Ambac couldn't perform on its own obligations to make good if a particular muni bond goes into default, Buffett would step into the breach and make good himself.

That would be a nice thing for the holders of insured municipal bonds. Why not have an extra layer of insurance underneath the one you've already got? And it would be a nice thing for the bond insurers, too — if it were free. But it's not free at all. Buffett proposed to charge the companies like Ambac 50% of the insurance premiums that they themselves were getting from the bond issuers.

Think about it. First, municipal bonds rarely default. It's essentially unheard of. So companies like Ambac virtually never have to pay claims. Second, these companies have considerable reserves on hand to pay for those rare claims that may arise. Ambac, for example, has more than $20 billion.

So to take only a tiny risk, with that tiny risk only arising after all the insurance companies' reserves are exhausted, Buffett proposes to take half of the revenues earned by Ambac and MBIA. If they had agreed to Buffett's proposal they'd be gutting their future revenue stream — a stream they need to keep building their reserves to pay off their riskier bets in the mortgage-related arena.

That's no "rescue" at all. That's cherry-picking the companies' best and least-risky business line, completely ignoring their real needs to deal with their mortgage-related risks, and draining the companies of the money they'll need to make it in the future.

At least Buffett laid his cards on the table and made a concrete proposal that he was willing to back with real money. It was a crummy deal, but at least he meant it, and at least he fully disclosed everything about it. I suppose that should count for something.

Compare that to other investors in the market today who are exacerbating the difficulties of the bond insurance companies, and trying to profit by stirring up panic among investors in those companies.

I won't name names. But there's one hedge-fund manager who seems to show up on TV almost every day with a new version of how much trouble the insurers are in over their mortgage-backed commitments. Every time he opens his mouth his estimates of the losses go up. First it was tens of billions of dollars, then hundreds. I don't think he's hit a trillion yet, but maybe I just wasn't listening.

Then there's another hedge-fund manager who thinks these companies are worth more dead than alive, and is publicly urging them to go out of business and liquidate themselves.

Then every couple of days some "expert" shows up on television with a false story about how this or that government agency is arranging this or that bailout.

Wonder why the stock market is so volatile? I think in large part it's because of people like this, and the willingness of the financial media to uncritically give them air time and column inches to spew their speculations, guesses and what I consider to be downright lies into the mind of the public.

The self-interested proclamations of these people about the bond insurers can move the markets because these companies occupy a very important position in the economy. If their insurance commitments were to be broken, that would downgrade the value of trillions of dollars worth of bonds held by banks, brokers and plain folks like you and me.

This is where the author of a column like this is supposed to say, "There ought to be a law." Shouldn't there be some way of preventing these self-promoters from using the media for their own ends, or at least forcing them to shut up?

Actually, there already are laws about this — those governing securities fraud and market manipulation. But these charges are incredibly hard to prove in court. And a great deal of respect is given to the sanctity of the First Amendment right to free speech, even if you go on TV and lie about companies whose stocks you are short. And that's the way it should be, if we want to stay free in this country.

As for Buffett, there's certainly no law against making a greedy and rapacious business proposal.

And there's no law against stupidity, either. If the bond insurers are stupid enough to accept his proposal, so be it. Fortunately, it seems they are not.

If investors are stupid enough to think that Buffett is a saint, then so be it. Sadly, it seems that sometimes they are.

Just promise me you won't be so stupid as to think that every investment manager appearing on CNBC or quoted in The Wall Street Journal is handing down the objective truth with no self-interest involved. Those guys want you to panic. They want you to make a mistake and sell at the very bottom.

The timing is very tricky, and it's easy to get hurt in the short term. But it doesn't take a genius to see that with so much panic in the air, and more and more of it being ginned up every day in the media, this is the time to be buying judiciously.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors.

Buying municipal bond insurance is nothing more than taking a brick house and saying it is a better investment if you wrap it in duct tape.

Every time Buffet speaks, he moves the market to his advantage. The same is true for every other magnate who amassed their fortune in the markets. Their agenda is never part of the MSM story.

I'm a noob to investing, but I figured that out easily enough. Sort of like Carville letting Republicans know how they can fix their problems.

2 posted on 02/16/2008 8:16:54 AM PST by BallyBill (Serial Hit-N-Run poster)

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