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Warren Buffett: J.P. Morgan Or Don Corleone? (MBI, ABK, AIG)
After his recent action to re-insure $800 billion in tax-exempt bonds, it's easy to see Warren Buffett as the reincarnation of J.P. Morgan, the man who saved America's economy in the late 1800s.
Yes, it's easy to cast Buffett in the role of hero, but it might not be accurate. He's a savvy business man, and those troubled bond issuers who sign on with him might actually be doing the equivalent of marrying into the Corleone family from "The Godfather" movies, where protection comes at the price of control.
Subprime's 100-year-old Cousin
In 1893, the U.S. economy was in significant trouble when the population began redeeming silver-notes for gold. The silver notes were financed though high-yield bonds, backed by public companies. Suddenly the financial-burden became too heavy and a wave of bank failures ensued. The debacle extended beyond banks, with many other key industries failing as well, including railroads. Sounds a little like the subprime meltdown, doesn't it?
When the dust cleared, over 10,000 American businesses and 500-800 banks went belly up. The crux of the entire failure was arguably the U.S. government's failure to act. Political jockeying took precedence over policy change to assist the economy and public. Then during the panic of 1893, legendary financier and banker J.P. Morgan stepped into save the day. He helped the U.S. Treasury re-establish the previous $100 million surplus with a bond issue derived from gold. (To learn more about these turbulent times, see The Bond Market: A Look Back.)
In a way, Warren Buffett's most recent action to re-insure $800 billion in tax-exempt bonds can be seen as a walk in J.P. Morgan's shoes of the 19th century.
Do You Need Me To Reassure You?
So, what's all this business about re-insurance? Basically, it comes down to credit, and it seems everyone is worried about their credit right now, especially with mortgage-defaults picking up more and more steam. For bond insurers, credit is everything, and top firms need to keep their 'AAA' status in order to continue business as usual.
Big firms with municipal bond businesses at risk include MBIA (NYSE:MBI), Ambac (NYSE:ABK) and AIG (NYSE:AIG). If Buffett and team were to step in and "re-insure" the muni-debt obligations of these companies, the bond insurers would have no trouble keeping their 'AAA' status, something that would put investors at ease. (To learn more about bond ratings, read What Is A Corporate Credit Rating?)
No More Mr. Nice Guy
When examining the entire situation, there's plenty more than meets the eye here. First, Buffett is no dummy, and he's certainly not trying to help bond insurers, just for the sake of charity. Buffett's move is a shrewd attempt to bottom-fish the municipal bond-books of mega-insurers, while they're on their knees. Fact is, Buffett is darn good at the insurance business, and while his most recent $800 billion offer to bond insurers may seem like a benevolent gesture, but it's not. It's business, plain and simple.
Big bond insurers know that with Buffett's offer comes a huge price tag, too. In essence, accepting Buffet's offer would mean losing their municipal-bond books. What's more, Buffett has never been a fan of more risky debt instruments like, collaterallized debt obligations, and may likely pressure the firms to move away from these instruments, once he's firmly rooted within.
Bottom Line
Basically, if bond-insurers were to accept Buffett's offer, it would be like marrying the daughter of The Godfather. Sure, you might be able to get on with your life, but you would always know Don Vito Corleone is looking over your shoulder. More than likely, bond insurers are going to think twice before marrying into Buffett's family.
This story is going to take some time to unfold, but as of now, I expect bond insurers will hold out as long as possible. Buffett might have to make it a "shotgun wedding" to get bond insurers to the chapel.
To learn the dangers of structured debt products, see CDOs And The Mortgage Market and The Fuel That Fed The Subprime Meltdown.
Yes, it's easy to cast Buffett in the role of hero, but it might not be accurate. He's a savvy business man, and those troubled bond issuers who sign on with him might actually be doing the equivalent of marrying into the Corleone family from "The Godfather" movies, where protection comes at the price of control.
Subprime's 100-year-old Cousin
In 1893, the U.S. economy was in significant trouble when the population began redeeming silver-notes for gold. The silver notes were financed though high-yield bonds, backed by public companies. Suddenly the financial-burden became too heavy and a wave of bank failures ensued. The debacle extended beyond banks, with many other key industries failing as well, including railroads. Sounds a little like the subprime meltdown, doesn't it?
When the dust cleared, over 10,000 American businesses and 500-800 banks went belly up. The crux of the entire failure was arguably the U.S. government's failure to act. Political jockeying took precedence over policy change to assist the economy and public. Then during the panic of 1893, legendary financier and banker J.P. Morgan stepped into save the day. He helped the U.S. Treasury re-establish the previous $100 million surplus with a bond issue derived from gold. (To learn more about these turbulent times, see The Bond Market: A Look Back.)
In a way, Warren Buffett's most recent action to re-insure $800 billion in tax-exempt bonds can be seen as a walk in J.P. Morgan's shoes of the 19th century.
Do You Need Me To Reassure You?
So, what's all this business about re-insurance? Basically, it comes down to credit, and it seems everyone is worried about their credit right now, especially with mortgage-defaults picking up more and more steam. For bond insurers, credit is everything, and top firms need to keep their 'AAA' status in order to continue business as usual.
No More Mr. Nice Guy
When examining the entire situation, there's plenty more than meets the eye here. First, Buffett is no dummy, and he's certainly not trying to help bond insurers, just for the sake of charity. Buffett's move is a shrewd attempt to bottom-fish the municipal bond-books of mega-insurers, while they're on their knees. Fact is, Buffett is darn good at the insurance business, and while his most recent $800 billion offer to bond insurers may seem like a benevolent gesture, but it's not. It's business, plain and simple.
Big bond insurers know that with Buffett's offer comes a huge price tag, too. In essence, accepting Buffet's offer would mean losing their municipal-bond books. What's more, Buffett has never been a fan of more risky debt instruments like, collaterallized debt obligations, and may likely pressure the firms to move away from these instruments, once he's firmly rooted within.
Bottom Line
Basically, if bond-insurers were to accept Buffett's offer, it would be like marrying the daughter of The Godfather. Sure, you might be able to get on with your life, but you would always know Don Vito Corleone is looking over your shoulder. More than likely, bond insurers are going to think twice before marrying into Buffett's family.
This story is going to take some time to unfold, but as of now, I expect bond insurers will hold out as long as possible. Buffett might have to make it a "shotgun wedding" to get bond insurers to the chapel.
To learn the dangers of structured debt products, see CDOs And The Mortgage Market and The Fuel That Fed The Subprime Meltdown.
by
Mark Whistler
Mark Whistler is the author of the book "Trading Pairs", published by John Wiley & Sons in 2004, and he is one of two creators of PairsTrader.com. Mark's new book, "Trade With Passion and Purpose: Spiritual, Psychological and Philosophical Keys to Becoming a Top Trader" is available at Amazon.com. Mark's trading specialty is statistical arbitrage, although he writes and conducts research for the Oxford Club and Mt. Vernon Options Club. Some of his other writing credentials include The Motley Fool, Active Trader Magazine, BullMarket.com, OptionInvestor.com and Working-Money online.
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