Bond Insurers’ Woes Prompt Interest From Buffett, Congress

Last Update: 2/12/2008 7:18:08 PM

By Judith Burns
Of DOW JONES NEWSWIRES

WASHINGTON (Dow Jones)–Concerns about potentially massive losses at bond
insurance firms have generated an offer from value investor Warren Buffett and
could prompt Congress to consider a federal bailout, investors and academics
said.

Buffett on Tuesday made an offer to reinsure up to $800 billion in municipal
bonds at Ambac Financial Group Inc. (ABK), MBIA Inc. (MBI) and Financial Guaranty
Insurance Co. In an interview on CNBC, the Berkshire Hathaway Inc. (BRKA, BRKB)
executive said one of the firms declined the deal even though he gave all three
companies 30 days to find a better one. Late Tuesday, Ambac turned down Buffett’s
reinsurance offer.

Bond insurers won’t leap at the offer, but could be forced into it by state
regulators who have the power to take over troubled firms, said William Ackman, a
managing member of Pershing Square Capital Management, a hedge fund that holds
short positions in bond insurance holding companies and stands to profit from
their losses.

“I like the Berkshire solution. I think it’s a home run,” Ackman said at a forum
Tuesday at the Hudson Institute, a Washington, D.C., think tank.

Ackman sees Buffett’s proposal as a way to prevent further downgrades of bonds
insured by the distressed firms, thereby averting fears of massive selling that
would punish muni-bond investors and municipalities looking to issue new debt.

“It’s not just about making money for Buffett,” said Ackman.

Congress could weigh in as well. A House Financial Services subcommittee on
capital markets plans to hold a hearing Thursday on bond insurers; a
congressional source said Buffett was invited to testify but won’t attend.

Bond insurers’ woes may prompt calls for a government bailout, federal oversight
of the insurance industry and closer scrutiny of the largely unregulated trading
in derivatives such as credit default swaps, according to a report issued Monday
by the Congressional Research Service.

“With the possibility of wider financial damage spilling over from bond insurer
difficulties, various market participants and government regulators have broached
the idea of some sort of rescue for the troubled insurers,” the report states. It
added that unless “a single, very well capitalized individual or firm becomes
convinced that buying out a large bond insurer made business sense,” the odds of
a private rescue seem small.

While the report notes the Federal Reserve brokered a rescue a decade ago when
markets were roiled by the collapse of Long Term Capital Management, a
Connecticut hedge fund, it said uncertainty about whether bond insurers need to
be rescued - and how much it would cost - have stymied a similar effort now.

Concerns center on so-called “monoline” bond insurers that guarantee that bond
holders will receive interest payments and have their principal returned in the
event of a default by the bond issuer.

Once a low-risk business that catered to municipalities whose bonds had little
risk of defaulting, monoline insurers now face risks from insuring asset-backed
securities, whose default rates may be much higher. Other risks stem from
monoline coverage through credit default swaps, which may be freely traded over
the counter and aren’t regulated by state insurance departments, the Securities
and Exchange Commission or the Commodity Futures Trading Commission. Different
accounting rules apply to swaps and require they use market prices, subjecting
them to swings in value that don’t apply to traditional insurance.

Credit ratings for monolines are falling amid rising risks and defaults, with
Standard & Poor’s slashing ratings for ACA Financial Guaranty Corp. to junk
levels, the congressional report notes.

A bailout could be costly, with some estimating the price tag might reach $240
billion, according to Drexel University professor Joseph Mason, who took part in
the Hudson Institute event. Mason questioned the wisdom of bailing out banks and
government-backed mortgage lenders such as Fannie Mae (FNM) that have significant
exposure to monoline insurers, suggesting some sophisticated investors “can and
should fail.”

Bailouts aren’t the only answer for “clearly insolvent” bond insurers, according
to James Chanos, a managing partner at Kynikos Associates, a hedge fund that
often takes short positions in stocks, speaking at the same Hudson Institute
event.

Chanos urged U.S. regulators to rethink restrictions on mutual funds and others
that require them to invest chiefly in investment-grade credit instruments,
saying that’s given rise to a system that is constantly gamed and gives investors
“a false sense of security.” He suggested investors might be better off if money
managers had more leeway, provided they meet their duty to act in the best
interest of investors.

Sean Egan, founder of Egan-Jones Ratings Co., a credit-rating firm, recommends
“rapid action” by regulators, including labeling which rating firms are paid by
issuers and which are paid by investors, the business model used by his firm.
Egan said clear labeling would alert investors to potential conflicts that might
color ratings.

-By Judith Burns, Dow Jones Newswires, 202-862-6692; judith.burns@dowjones.com

(END) Dow Jones Newswires

February 12, 2008 19:18 ET (00:18 GMT)

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