Can one man stave off a global recession?
First he took on Equitas – freeing Lloyd’s of the albatross around its neck and helping secure its market-changing rating upgrade. Then he bought 3% of Swiss Re at a time when the world’s largest reinsurer needed a boost.
Now Berkshire Hathaway CEO Warren Buffett – the world’s third richest man and the acclaimed Oracle of Omaha – is offering to be a knight in shining armour once again.
This time it's to aid the struggling bond insurance market. In a unique deal he has offered to reinsure $800bn of local US government securities.
Far from giving his protection away for free, Buffett is asking for 150% of the existing unearned premium reserves of the companies in question. But he still thinks it’s a good deal and one that will help to serve “the greater public good”.
Given the current climate, the monoline bond insurers may well be forced to agree.
In January, the situation went from bad to worse for bond insurers Ambac, MBIA and Financial Guaranty Insurance Company (FGIC).
The US subprime collapse was trickling through to these specialist insurers, which guarantee the global debt markets.
“Your first reaction may be that this is an excessive premium
MBIA revealed it was initiating a $2bn capital raising exercise after a $3.3bn write-down associated with subprime losses. This was in order to maintain its all-important triple-A rating. It did not stop rating agency Moody’s from placing it on review for downgrade.
Fellow bond insurer Ambac revealed a $3bn fourth quarter loss in its results. Rating agency Fitch promptly downgraded it two notches to an “AA”.
After revealing a $1bn shortfall, FGIC was also downgraded to an “AA” – first by Fitch and then by Standard & Poor’s.
Because bond insurers rely on exemplary triple-A ratings in order to remain in business, downgrades will have dire consequences.
Their downgrades will also have a knock-on effect on the securities they cover and are likely to lead to further economic turmoil in the global debt markets.
Bond insurers collectively insure $2.4trn of debt around the world.
As the bond insurers’ woes played out, Julian Spence, senior vice president of Transatlantic Re London, summarised the mood at a debate in London. “Market sentiment has changed in the last week.” He said bond insurance was an “area everyone was looking at with anxiety”.
“This approach has the appeal of serving the greater public good
Now Warren Buffett – backed by the world’s only triple-A rated reinsurer Gen Re – has offered to step in and provide security. But it’s at a cost and has excluded subprime insurance policies, focusing only on offering cover for government municipal bonds.
Ajit Jain, president of Berkshire Hathaway Reinsurance/Gen Re, outlined the proposals in a letter to MBIA’s bankers at Lazard Ltd. They include assuming the municipal bond portfolios of several of the monoline companies for a premium of 150% of the existing unearned premium reserves of the companies.
“Like many potential reinsurance buyers, I recognise that your first reaction may be that this is an excessive premium, and I want to offer you upfront the thought processes that led me to conclude that this is in fact a fair proposal that achieves important objectives for both parties,” reassured Jain.
Having outlined his thought processes, Jain added: “This approach also has the appeal of serving the greater public good, not an unimportant consideration for us, both as a matter of principle and as a company with a vested interest in national economic conditions.”
“I would submit that our proposal at the pricing levels we require is actually a cheap way for MBIA to raise capital as compared to other alternatives and is therefore of great benefit to MBIA’s owners and their municipal bond policyholders,” Jain concluded.
Ambac has rejected the deal, saying it “would result in little to no net capital relief to support Ambac’s ratings”. MBIA and Financial Guarantee have yet to return their verdicts.