Heads I win, Tails I don’t Lose Much

Published on February 13, 2008

Heads I win, Tails I don’t Lose Much

February 13, 2008

Mr. Buffett has called bond insurers’ bluff by offering to take on their municipal bond risks and leaving them with more troubled structured finance businesses, according to latest business news. Interesting!

Here are the key elements of the full proposal as sent by Ajit Jain, President of Berkshire Hathaway Reinsurance, to MBIA’s bankers at Lazard Ltd.

The key elements of the proposal we described to the Superintendent were: (1) we would raise the capital level in our monoline insurer, Berkshire Hathaway Assurance Corporation (BHAC), to $5 billion; (2) we would assume by reinsurance the muni bond portfolio of several of the monoline companies for a premium of 150% of the existing unearned premium reserves of the companies (with respect to two of the leading companies this would result in a combined unearned premium reserve of $6 billion, plus $3 billion for a total premium of $9 billion which, with the increased capital contribution to BHAC would result in approximately $14 billion of assets available to meet the combined $600 billion or so of total principal value of municipal bonds insured by these two companies); (3) we would undertake not to reduce BHAC’s assets by dividends, fees, etc., for a minimum period of ten years; and (4) we had furthermore proposed that, if the companies found a preferable solution during the first 30 days of our cover, they could have a no-questions-asked walk-away option in consideration of a break-up fee that would be paid to us.

Check here for definition of a muni bond? I would suggest you read full proposal. An interesting letter and rationale for charging premium that some may consider “excessive”. As you would have noticed, the offer excludes the bond insurers’ structured finance businesses, which have billions of dollars of exposure to complex mortgage-related securities known as collateralized debt obligations (CDOs).

Now that’s what is “heads I win, tails I don’t lose much” (or do I at all?). BHAC knows that all these insurers are facing difficult time and will have herculean task to raise capital. But the question is, will the muni bond insurers accept the proposal. They know they don’t have business without Muni to support CDOs. As Jim Chanos, head of short selling hedge fund firm Kynikos Associates LP, said, Buffett is trying to show that “the emperor has no clothes,” while he builds a bond insurance business of his own.

Markets went-up, but gave-up half the gains by the close. I shall only change my perspective when markets crosses Nov Lows. Till then , I remain, Bearish bullish,

Profitable trading, OP

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