Buffett: Why Insure Munis When You Can Buy Them Instead?

My fabulous new colleague Agnes Crane notes something interesting: even as he cools on the idea of selling municipal bond insurance, Warren Buffett (BRK.A) has been loading up on municipal bonds. Why would Buffett want to take municipal credit risk in the bond market, but not want to take the same credit risk by selling insurance? I think there are at least five reasons:

1. Insurance, by its nature, is highly leveraged: the amount of capital that Buffett would have to set aside were he to insure $1 million of municipal bonds is tiny — and possibly even zero, at the margin. But leverage is not the kind of thing that Berkshire’s investors want to see right now. They’d prefer him to just spend $1 million of his cash on municipal bonds — at least that way you can’t lose more than you’ve spent.
2. Default risk goes up when the issuer is insured — it’s the moral-hazard problem. Buffett might well be interested in buying uninsured bonds because he knows that municipalities will be hesitant to default on their own citizens. But if a bond is insured, the municipality knows that its citizens will still get paid out by insurers, and that makes it easier to take the decision to default.
3. It’s easier to pick and choose credits if you’re buying in the secondary market than if you’ve set up shop as a bond insurer: a bond investor will shun most credits, but it looks pretty bad when an insurer says no to most credits.
4. An insured bond is a credit risk all the way to maturity, while Buffett can sell his munis as easily as he bought them. Maybe this is just a trading play, rather than a buy-and-hold investment.
5. Most importantly, if Buffett has been buying up munis cheap in the secondary market, he’s probably getting much higher yields than he could ever charge in the primary market as an insurer. He might be able to charge a percentage point or two to insure an issuer against default, but I’m sure he can find munis for sale at spreads much wider than that.

Given all these reasons to buy bonds rather than insure them, I do wonder what’s going to happen to the monoline market. Historically, it’s been a license to print money — but it might be a very long time before it re-emerges.

Comments

[Gtarras:]

"Given all these reasons to buy bonds rather than insure them, I do wonder what’s going to happen to the monoline market. Historically, it’s been a license to print money — but it might be a very long time before it re-emerges."

I am sure when/if things get to normal, BHAC will switch back into insurance, as all of the 5 points will turn in favor of a wrap vs. cash investment.

Jun 09 02:00 PM

[Tom Armistead:]

Buffet is buying munis because the return is good compared to the risk: there is a big spread.

That demonstrates that the market for municipal bond insurance is waiting, because credible insurance will reduce borrowing costs. There will be plenty of room for an underwriting profit.

It should be born in mind that Buffett's primary business strength is that he can always write a check when he wants to. Given the uncertaintly about the economy, and the opportunities for those who have cash when others don't, he no doubt prefers a more liquid position to incurring liabilities that can extend for 30 or 40 years.

Jun 09 05:00 PM

[The Geoffster:]

Barney Frank will make sure no munis default.

Jun 09 06:53 PM

[Analyst Mayank:]

BHAC writes more munis and recieves more cash. Now what to do with that cash in what they might believe is an overbought market? Besides, when you have so much of cash in an illiquid market its safer to put it in a place where the cash flows are certain.

Jun 10 10:48 AM

[19 years ol...:]

Well it's rather weird to me that the default risk goes higher when a bond is insured,true question is whether this bond NEED to be insured or is it just like,let's say a "back up" ? And Last but not least thing:what happen to the bond yielding when it is insured ? is it profitable in the end for the issuer to pay premiums annually ? thanks for answer

Jun 11 03:51 PM