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Warren Buffet to the Rescue

Posted February 13, 2008

"He cheerfully admits that this is capitalism, red in tooth and claw, at its finest… And still the market applauds him as a hero." — John Stepek

by John Stepek

Baltimore and London – (TFN):  You have to admire Warren Buffett.

He's offered to relieve the ailing monoline bond insurers of their very best assets, leaving them with all the subprime rubbish that got them into trouble in the first place. It's a viciously cut-throat offer to a group of crippled opponents, kicking them when they're down and defenceless.

He cheerfully admits that this is capitalism, red in tooth and claw, at its finest. "I'm not doing this so that St Peter will let me in at the pearly gates. We are doing this to make money," he said.

And still the market applauds him as a hero - "Buffett to the rescue!" as one Forbes headline put it.

The man has style…

Warren Buffett's offer to take all the best bits from the monoline insurers is a smart move. He has said his Berkshire Hathaway investment vehicle will put up $5 billion to reinsure $800 billion worth of municipal bonds currently backed by the monolines. These are bonds largely issued by local government bodies in the States to raise money for public works.

Let's recap on what's happened so far. The monolines are big insurers, who basically rent out their AAA-credit ratings to bond issuers who don't have high credit ratings. In the good old days before subprime, most of their business was taken up with insuring these municipal, or 'muni' bonds.

This was all fine. Although many 'muni' bond issuers don't have much of a credit history (and therefore find it difficult to get decent credit ratings themselves) they are ultimately backed by taxpayers, and thus pretty safe bets. Indeed, the historical default rate is less than 1%. So monolines would back the bonds; the muni issuers would benefit from getting the cheaper borrowing rates that come with a AAA-credit rating; and the monolines would get a nice fee.

Warren Buffet to the Rescue: The monolines discover subprime

If they'd stuck to that nice little arrangement, everything would have been fine. But they didn't. Read on to learn how the monolines destroyed themselves.

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Posted by John Stepek · Filed Under US Stocks and Markets 

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