TOPICS > Economy

Billionaire Buffett Offers to Help Insure Municipal Bonds

February 12, 2008 at 6:15 PM EDT
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Billionaire investor Warren Buffett announced Tuesday that he would help shore up three insurance bond firms by offering additional insurance on up to $800 billion in municipal bonds. The Wall Street Journal's David Wessel explains how bond insurers impact Wall Street and how Buffett's may help ease financial concerns.

JIM LEHRER: And to Jeffrey Brown for item two on the economic list of the day, Buffett to the rescue.

JEFFREY BROWN: For the general public, bond insurance companies may be one of the more obscure puzzle pieces in the current financial turmoil. But on Wall Street, the plight of these businesses has been closely watched and had an impact on moving the markets on any given day, including today, when billionaire investor Warren Buffett offered to help three insurers of municipal bonds by offering a second level of insurance.

David Wessel, the economics editor of the Wall Street Journal, joins me now to help explain.

Well, David, they’re called monoline insurers. Tell us, first, what they do. And how did they get in trouble?

DAVID WESSEL, Wall Street Journal: These insurance companies are in what has been a very sleepy, profitable business. What they did was a municipality, a county, a state government would issue bonds.

Investors wouldn’t want to do the homework to find out if the local government was good for the money, so the insurance company put their Good Housekeeping seal of approval on it, the “AAA” rating. The municipality would pay for that service, and they would be able to borrow at a cheaper rate.

It was a very nice business, but the companies got a little bit greedy. They saw a chance to make more money by diversifying into what they thought was a similar business: insuring securities that are linked to mortgages.

And as we know, that turned out to be a very risky business. And they didn’t have enough capital set aside for being in such a risky business.

JEFFREY BROWN: So this is all very much tied to the market, the housing problems that we’ve been hearing about for so long. Do we know the extent of the trouble that they’re in?

DAVID WESSEL: Well, we don’t really know the extent of the trouble they’re in because we don’t know how far house prices are going to fall.

But here’s one example. One of the companies, known as MBIA, has already lost $714 billion on mortgage-backed securities. That compares to their losses over their previous 36-year history of around $900 billion.

And this company in the fourth quarter wrote down the value of their portfolio by over $2 billion. So the hole is very big, and they don’t have enough capital set aside to stand behind these things, so they’re in danger of losing their rating as “AAA” companies.

And nobody wants to buy insurance on a “A” bond from a company that’s not “AAA,” because what’s the point of the insurance if the insurance company is more financially vulnerable than the county or local government that issued it?

Buffett offers a bailout

RAY SUAREZ: So today you have Warren Buffett step in and offer to re-insure parts of the business of these companies. Now, what does that mean? What's he doing?

DAVID WESSEL: Well, the reason everybody is upset about this is because, if these companies are downgraded, then all the banks and other investment companies that own these securities that they've rated will have to take a hit. And it may make them less willing to lend.

So there's been this big effort, led in part by the insurance commissioner in the state of New York, Mr. Dinallo, but with help from the Federal Reserve Bank in New York and the Treasury, to come up with some kind of rescue plan for these companies.

What Mr. Buffett did is come through today and say, "You have a lot of responsibility to guarantee municipal bonds. I will take over $800 billion of those bonds, guarantees. I'll take a big chunk of your business for a profit."

He made no secret that he's doing it because he thinks it's a good business. It's not a favor to the system; it's not charity. He's willing to take about two-thirds of their municipal bond insurance business and say, "I'll take that on." He's trying to build a business here.

Now, some of the companies said, "Gosh, thanks, but no thanks," because he's offering to take their good business and they're trying to figure out how to finance their bad business. And he isn't offering to take that.

JEFFREY BROWN: Well, explain that a little bit more. So, I mean, as you said he was very clear today when he announced this that this was for him a way of making some money and maybe helping out the system at the same time. But this is the municipal bonds only that he's talking about.

DAVID WESSEL: That's right. They have insured about $1.2 trillion in municipal bonds. He said, "I will take responsibility for $800 billion of that, and I will charge you a premium equal to 50 percent more than the premium you're collecting."

And he's willing to put -- he has a lot of money. He's willing to put $5 billion of his money into this business. He'd like to be in this business. He is not offering to bail out the companies, and he is not offering to take responsibility for their really risky securities, these subprime and other mortgage-backed securities.

JEFFREY BROWN: And so where would that leave those riskier investments?

DAVID WESSEL: Well, these companies would be able to -- the system would be a little safer, because these municipal bonds would be insured by a rich person, but some other plan would have to be found to raise capital for these companies or some other investor who's willing to take over the responsibility for insuring these more risky securities.

JEFFREY BROWN: Now, you said that one company rejected it already. I think the others are looking. What was the response, the broader response on Wall Street and among people who are worried about what's going on more broadly?

DAVID WESSEL: Well, as you noted earlier in the program, the stock market liked this, because it is very worried about the number of shoes that are dropping. And any shoe that can be kept on the feet of the insurance companies, if you will, is one less thing to worry about.

So the stock market overall rose, but actually the stocks of these companies fell, because this may not be a great deal for the investors in these companies. It may be a good deal for the system as a whole and for Warren Buffett, but not to the people who own stock in MBIA and the other companies that are in this business.

JEFFREY BROWN: Is part of the good reaction just based on the fact that it is Warren Buffett who is stepping in here?

DAVID WESSEL: I'm sure. Warren Buffett always carries a certain cachet, but I think also there's a sense that, how will we know when this thing, broadly defined, is over?

And how we know it's over is when really sophisticated investors say, "OK, the prices have fallen so low that they're such a bargain that I have all this money I'm going to come in and buy them." And to the extent that big investors will come in and buy mortgages, or take over insurance responsibilities, or buy land or buy houses, people will begin to feel maybe the end is at hand, that we've hit bottom.

And so I think one reason is it's just good to know that Warren Buffett thinks there's some money to be made here. If more people do that, maybe the crisis will come to an end.

JEFFREY BROWN: I noticed, though, because I was reading the interview he did with CNBC earlier today when he announced this, he didn't seem to know where the bottom was for those worrisome loans. He said flat out that he wasn't sure where it was going after all.

DAVID WESSEL: That's absolutely right. I mean, I wrote a column in the Wall Street Journal that said if Ben Bernanke, the chairman of the Federal Reserve, could know just one thing, it would be, how much farther and how much longer will home prices fall?

So much of the economy and Wall Street is in a mess because they just don't know how much worse it's going to get.

Ripple effect could harm everyone

JEFFREY BROWN: And let me ask you, finally, we're talking about these -- well, as I said, for most people, fairly obscure and arcane pieces of the puzzle, but why should the rest of us care? Why does all this matter for us?

DAVID WESSEL: That's a good question. One thing is that, if municipalities are unable to get insurance, it may affect their ability to borrow, to build roads and schools and sewage plants and stuff like that.

So a lot of us are taxpayers. We have an interest in making it possible for our municipal governments, county governments, state governments to borrow.

But the second and probably broader thing is that if these companies -- the whole system has become vulnerable to the weakest links. And if these companies get in trouble and banks and investment banks have to take a big hit, they're going to be less willing to lend to all of us, to businesses and consumers.

And we're at a point in the economic cycle where we don't need them to have any more reasons to be reluctant to lend. So to some extent, if we can fix this problem, it may prevent another problem down the road.

JEFFREY BROWN: All right, David Wessel of the Wall Street Journal, thanks a lot.

DAVID WESSEL: You're welcome.