Saturday, December 29, 2007

Monolines Death Watch

"'The new triple-A-rated player will take business from Ambac, MBIA and others because their own triple-A ratings are suspect,' said Ed Grebeck, chief executive of Tempus Advisors, in Stamford, Conn. ... The risk to Mr. Buffett's new business is that municipal governments decide that its prices are too high and opt to issue debt without insurance instead. ... Bond insurers help municipalities keep their borrow costs low. At least until recently, the fee paid to the insurer effectively extended its triple-A rating to the borrower. That allowed governments to pay lower interest rates on the bonds they issued, saving taxpayers money. ... Few such bonds ended up in default over ther past 30 years, making the business highly profitable. ... Buffett said his new company will charge more than other bond insurers because of what he calls the 'moral hazard' inherent in bond insurance. That is, governments that have insurance could take advantage of it by borrowing and spending far beyond their means to repay the debt, and simply default, leaving the insurer on the hook", WSJ, 28 December.

"Bond insurers put on a brave face in welcoming a new rival backed by Warren Buffett [WB], even as investors dumped their shares on fears that a well-financed competitor would cripple their beleagured business. ... Buffett's entry 'is a significant validation of the valuable role our industry plays in helping public entities issue debt,' said Williard Hill, chief marketing officer for MBIA. ... Buffett's company won't insure structured-finance products such as collateralized debt obligations or asset-backed securities which require more capital", WSJ, 29 December.

If monolines muni bond insurance business was profitable, how did it lower municipalities borrowing costs? This business required municipalities having stupid financial officers, and was supported by the rating agencies, like Moody's, 19% owned by WB. WB has a key point applying "moral hazard" to governments. Apply it to California, see my 28 December post. Better still, Uncle Sam. How will Unc repay the national debt? Easy, inflation; that's Helicopter Ben's job, to reduce the real value of Unc's debt. "But I thought it was to stabilize the economy". No. Did you ever hear of the "period of the peg", 1942-46? No? See my 17 September post. "The Humphrey-Hawkins bill said the Fed was to ... ". So?

I disagree with Hill; WB's entry into the muni bond insurance business shows it lacks economic value for bond issuers. Why? WB is smart. His company will only sell insurance that is expected to be profitable. Ex ante, municipalities buying this insurance will lose discounted present value. If not, how will WB profit? This is a zero-sum game. Mike Shedlock has a nice post on this at, 28 December.

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