Berkshire makes play for troubled firms' muni risk

Buffett says plan would make bond debt AAA again; CDOs aren't included

NEW YORK (MarketWatch) -- Warren Buffett's Berkshire Hathaway on Tuesday came off the sidelines in the mortgage-market crisis, unveiling a plan to take on $800 billion of liability in municipal bonds currently insured by three troubled firms.

The undertaking would represent Buffett's biggest, and boldest, foray into the bond insurance business to date, and it stands to earn billions of dollars if successful.

Shares of some bond insurers initially gained ground on the news, lifting the broader market on hopes the plan will relieve one of the main pressure points in the current credit crisis. MBIA and Ambac shares, however, lost ground at last check, with MBIA down $1.61, or 12%, at $11.97 and Ambac off $1.38, or 13% , at $9.10.

In recent weeks, state insurance regulators in New York intensified talks with large financial firms in hopes of cobbling together a lifeline to assist the struggling bond-insurance industry. Berkshire Hathaway has begun to insure muni bonds in New York after getting a license quickly from the state Insurance Department.

And in January, the National Association of Insurance Commissioners said that it's working with Berkshire to help it expand quickly and operate in multiple states.

Buffett, the chairman of Berkshire, said that last week his firm offered to take on $800 billion worth of municipal bond risks currently covered by three of the world's largest bond insurers.

Speaking on CNBC, Buffett said the firm made the offer to Ambac Financial
(ABK:

Buffett said that under the proposal, Berkshire would assume the liability for the bonds in exchange for a payment from the current insurers of 1.5 times the premium they're currently receiving.

He said one firm has rejected the offer, and the other two have not yet responded.

Buffett's offer would cover municipal bonds but not the billions of dollars worth of complex securities known as collateralized debt obligations that Ambac, MBIA and FGIC have also guaranteed.

"We're doing this to make money," Buffett told CNBC, adding, "The world would know $800 billion in tax exempt bonds are AAA again."

Some observers questioned whether Buffett's plan will be enough to help the bond insurers because it excludes CDOs.

"Buffett's muni-reinsurance offer will provide some cash, but not address the core problem which is structured finance exposures," Egan Jones Ratings, a rating agency, wrote in a note to investors.

Bond insurers have been hit hard by the mortgage crisis. There's now concern that they'll have to pay big claims on guarantees they sold on mortgage-backed securities and CDOs.

Several bond insurers have already begun to lose AAA ratings, imperiling their business models. A more worrying consideration is that, when a bond insurer is downgraded, all the securities it has guaranteed are, in theory, downgraded as well. These companies have guaranteed more than $1 trillion of muni bonds, which could also lose AAA ratings.

Bailout possibilities

Concerns about the wider impact of trouble in the $2.4 trillion bond insurance business have encouraged some regulators to begin working on possible bailouts of specific companies. The New York Insurance Department, headed by Eric Dinallo, is urging big banks that are counterparties to the bond insurers to inject fresh capital into the companies and has hired boutique investment bank Perella Weinberg to advise on the plans. See full story.

Some bond insurers, such as MBIA, have been trying to keep their top ratings by raising new capital.

Buffett said that if bond insurers accepted his offer, which would likely pay off handsomely for Berkshire, the companies would free up capital and relieve pressure on their credit ratings.

The plan could help stabilize the muni bond market, an important source of financing for local governments and school districts that has begun to creak in recent months.

Buffett, whose firm earlier this year began reinsuring some municipal bonds, also said Berkshire is currently being paid a 2% premium for reinsurance, while the standard premiums are about half that. He said that difference reflects how nervous the market is about the bond insurers.

"We're getting double the premium at the moment to be the second payer," Buffett said.

Berkshire has a successfully swooped into different parts of the insurance business during times of stress, avoiding the underwriting cycle that's plagued the industry from its birth. Insurers usually vie for new business when times are good, eventually bringing down prices and threatening future profitability. When earnings drop, companies underwrite fewer risks, bringing prices back up again.

Buffett tries to do the opposite: taking on little or no risk when prices are low and piling in when rates surge.

In the wake of Hurricane Katrina, Berkshire generated huge profits by reinsuring catastrophe risks that few other companies wanted to take on at the time. As other reinsurers returned to the market and prices fell, Buffett stepped back.

Greg Morcroft is MarketWatch's financial editor in New York.

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Buffett says Berkshire Hathaway offered to reinsure $800 billion in muni bonds