Friday, December 28, 2007

Buffett's New Bond Insurer

By now everyone has probably read about this, but I just wanted to highlight something:

Warren Buffett is finally moving to make some money from the nation's credit crisis by starting a new company that will insure debt issued by state and local governments...

Unlike Berkshire's Geico property/casualty insurer which stresses its low rates, Buffett's new venture will charge a premium for its likely triple-A credit rating, a price local governments will probably be willing to pay to avoid the now "wobbly" credit ratings of other insurers that backed mortgage-related bonds that "could lead to massive losses and significantly erode their capital."

Here is a summary version of the balance sheets of MBIA, a major bond insurer, and Berkshire Hathaway at the end of the most recent quarter(left column) and the end of 2006(right).

Even after subtracting Berkshire Hathaway's 33 billion in goodwill from equity, we have equity/liability ratios of:

.56 for Berkshire Hathaway
.17 for MBIA

Which brings up an interesting dilemma. People are already questioning the validity of the current AAA-ratings of bond insurers. But credit agencies do not want to downgrade the existing bond insurers because it will set off a chain reaction of further downgrades. And now you have Berkshire Hathaway coming in with its Fort-Knox balance sheet, and everyone is definitely going to favor doing business with them. So what rating can you give to account for Berkshire Hathaway's clearly superior financial strength?

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