Warren Buffett com problemas?

Testing the waters

From The Economist print edition - 3/jan/2008
America's most admired investor dips a toe in a troubled market

“BE FEARFUL when others are greedy and be greedy when others are fearful.” Thus wrote Warren Buffett in the 2006 annual report of Berkshire Hathaway, his holding company. True to his maxim, in the last week of December Mr Buffett splashed out $4.5 billion for a majority stake in Marmon Holdings, an industrial conglomerate, and €300m ($441m) for a reinsurer owned by ING Group of the Netherlands. But his most intriguing investment, announced on December 28th, was his smallest: $105m to fund Berkshire Hathaway Assurance Corporation (BHAC), a start-up that will insure bonds issued by American states, cities and counties to finance schools, roads, hospitals and other public projects.

There are good reasons to be scared stiff about the bond-insurance business, an arcane but important part of the American financial system that has underwritten roughly half of the $2.6 trillion-worth of municipal bonds outstanding. Bond insurers win business because their pristine credit ratings signal to investors that they have deep enough pockets to pay claims if borrowers default. But those top-notch ratings are now hanging by a thread. Keen to diversify, the insurers jumped onto the housing bandwagon, underwriting billions of dollars of private mortgage-backed securities. Now they face the prospect of huge claims from investors whose subprime-laced assets have soured.
Some hedge-fund managers have been giving warning for years that the insurers' mortgage-related risks would one day overwhelm their flimsy capital bases. Rating agencies are belatedly reaching the same conclusion. On December 19th Standard and Poor's slashed its rating of ACA Financial Guaranty Corporation, a small insurer, to junk grade. The industry's bigger fry have also been told to shore up their capital fast or face downgrades. If that happens, the credit ratings of bonds underwritten by the insurers will fall, driving down their value and further crimping the lending capacity of bondholding banks. Borrowing costs for states, cities and counties will also rise.

There had been speculation that Mr Buffett would ride to the rescue by buying a struggling insurer. After all, he has repeatedly said that he is looking for “elephants”, $5 billion-20 billion deals that would soak up the cash that pours out of Berkshire's other businesses. And the firm has a history of snapping up insurance assets such as GEICO, now one of America's biggest car insurers, and General Re, a big reinsurer. Instead Berkshire has given birth to a mouse. Rob Haines of CreditSights, a research firm, estimates that, with a conservative leverage ratio, BHAC's capital will let it underwrite some $10 billion of business; MBIA and Ambac Assurance, two of the biggest firms in the industry, insure several times that amount each year.

Mr Buffett's caution is understandable. He still bears the scars from an ill-fated derivatives venture at General Re. (He may also be dragged into a separate fraud trial involving General Re, which is due to start on January 7th.) Bond insurers are now staring into their own abyss of liabilities, a legacy of lousy risk management. “When Buffett acquires, he wants successful companies with good management, and none of the bond insurers qualify on those counts at the moment,” says Donald Light, a senior analyst at Celent, a research firm. Better, then, to start with a clean sheet at BHAC, which will handle only municipal business and plans to charge a premium for use of its unblemished AAA-rating. If business is brisk, more of Berkshire's cash can be funnelled to the new firm, whose licence was approved by New York state's insurance regulator in double-quick time.

The regulator's alacrity is understandable: it reckons that Mr Buffett's move will be seen as a vote of confidence in a worryingly fragile market. The unspoken hope is that it will encourage other investors to overcome their fears. Few are as well-placed as Mr Buffett to do so, however. Reckless greed got the bond-insurance market into trouble; Mr Buffett's more refined gluttony can only do so much to get the industry out of it.