Market Jumps as Buffett Offers to Kill Bond Insurers

On Tuesday, the market rose on news that Warren Buffett had offered to take $800 billion in municipal bond guarantees off the books of Ambac (ABK), FGIC and MBIA (MBI). Buffett announced his offer Tuesday morning on CNBC, which you can watch here and here.

For those of you who did not see the segment or are too lazy to watch the clips - and I would normally put myself in the latter category - Buffett said, amongst other things, the following:

The offer was made last week. One company, now reported to be Ambac, declined. The other two have not responded.

Buffett did not think the companies would take him up on his offer.

When asked if the companies would essentially be signing their own death warrants if they took his deal, Buffett skirted the question.

Why would the three be signing their own death warrants if they accepted Buffett's offer? Because Buffett offered to take all the good stuff off the books, and leave the insurers with the crap.

Given that MBIA raised $1 billion in equity on Thursday, and Buffett made the offer on Wednesday, it appears that MBIA also understands that it would be signing its own death warrant if the company is left only with the crap (though Bill Ackman believes they signed their death warrants a long time ago).

The crap to which we are referring are collateralized debt obligations, or CDOs. Buffett had a few things to say about CDOs:

He cannot figure out the depth of the CDO problem.

He is not sure if anything can be done to solve the CDO mess.

It is very tough to value CDO securities.

None of Berkshire's companies own any CDOs.

In other words, the CDO market is a black hole that could take down the bond insurers even if they take him up on the deal, and the problems in the broad CDO market may be intractable.

Buffett's offer would go some way to solving the municipal bond market's problems. Buffett noted that:

Bonds insured by Ambac, FGIC and MBIA are trading below similar uninsured bonds.

The bonds are trading as if they are already uninsured.

There have been no forced sales of municipal bonds, which would occur if the insurers are downgraded since many funds cannot hold bonds that are not AAA-rated.

Perhaps most interesting, were Buffett's comments made in response to a question by Joe Kernan. Kernan said he assumed Buffett had been approached on every deal that has been done, and that Buffett turned down every one. Why, even though some securities had fallen 50%-60%? Buffet answered:

Buffett confirmed Kernan's assumption.

Simply because a security is down 50%-60% does not mean it is cheap.

He did not understand the securities that were offered.

Buffett also acknowledged that Berkshire had been offered to buy Countrywide Financial (CFC), which eventually sold to Bank of America (BAC), but declined.

Thus, the market rose on news of an offer that would, yes, stabilize the municipal bond market, but would effectively kill the bond insurers and as a result, is likely to be rejected. It will do nothing to solve the CDO problem, as the world's greatest investor admits he cannot understand CDO securities, let alone the depth of the CDO mess, and even states that there may be no solution to the CDO debacle.

Each piece of news from a Warren Buffett offering to bail out troubled financial products inches the market towards a resolution when investors can look past the tremendous problems in the financial system. However, Tuesday's news was only marginally positive since not only is it unlikely to come to fruition, it does nothing to solve the CDO problem, let alone the other problems such as CLOs, CMBSs, or rising credit card defaults, that are manifesting themselves in financial markets.

There is still some ways to go.

Comments

[Atl Bob]

Let me know if anyone else sees it this way....

Buffet offered 800 Billion for the muni's so they must be worth more than that. Which should lend a bit of credence to what MBIA has been saying- that they are not in as bad a situation as the Shorts have been yelling about. They have a huge book of business and it starts sounding like it would take an enourmous hit on the other business to drag them down. Also sounds like the ratings groups have been lax and now are trying to overcompensate. It's like everyone love to cite the worst scenario as if it the most likely scenario (or like they all took short positions first, then wrote their commentary).