Saturday, December 29, 2007

Will Warren Buffet someday own Pittsburgh?

A joke? not exactly. Fester has been diligently covering the linkage between the crisis in the municipal bond insurance market and the potential implications for the City of Pittsburgh. It's a big topic that is nearly impossible to keep esoteric-free. So wonks only will want to read further.

Suffice it to say that local governments in the US have a lot of debt in the form of municipal bonds. The City of Pittsburgh has long had such poor credit that it has had to purchase bond insurance in order to float debt in the bond market. Today virtually all the city's nearly $900 million general obligation debt is covered by bond insurance issued by one of the handful of firms that issue such insurance. The insurance means that if the city ever fails to make a bond payment, the bond insurer kicks in so there is less risk to whomever buys the bond. There is a cost to the city for this in the form of an additional premium to the bond insurer, but the payoff is that the city gets to issue debt at the bond rating of the insurer which is much by definition is higher than the city's. Why the bond insurance market operates as it does, and how insurers set premia, is something of a mystery to me. I am not alone in that perspective.

The problem is that the bond insurers are running out of money. That's a bit simplistic, but the bond rating agencies are looking to downgrade the bond insurers' credit ratings almost across the board. Since the only real product of a bond insurer is it's credit rating, that's pretty bad. It is a crisis akin to the sub-prime real estate crisis that makes more headlines. Municipal bond insurance just does not make for decent copy the way a foreclosed house does: no furniture on the street and virtually nobody to interview.

Where does warren Buffet come in? Warren likes a good deal and distressed municipal debt must look like an opportunity for him. That and he has big pockets. So just as the big wall street firms have been looking to Dubai and China for big cash infusions to cover their potential losses in the sub-prime credit crisis.... so too have the bond insurers have gone looking for sugar-daddy's to recapitalize and prevent ratings downgrades. There was talk that Buffet was going to do just that for one of the big Bond insurers Ambac, which insures some of the city's bonded debt. The news just yesterday is that he is instead going to try and build his own bond insurance company and thus leave Ambac out in the cold to fend for itself or find some other funder. So the next time the city refinances, Warren may be the insurer. Which raises an interesting question, if he does enter the bond insurance biz, will Warren Buffet insure future debt of the city of Pittsburgh? As of right now, the answer would be no only because news accounts say he is only looking to operate in 4 states that do not include Pennsylvania.

But there are only a few companies that exist in this business and they all seem to have some precarious finances these days. Like all such crises, it's not that it wasn't predicted by anyone. The bellwether report seems to be the 2002 report "Is MBIA Triple A" put out by Bill Ackman of Gotham Partners about one of the other major bond insurers. He now predicts that MBIA will be bankrupt by the 2nd quarter of 2008 which isn't too far away. What that means for Pittsburgh bonds insured by a bankrupt company is a bit of uncharted territory. The bond lawyers may have to earn their fees if that ever becomes a real question.

A more interesting question is whether Warren Buffet already insures the City's debt. Even without being a player in the bond insurance world, Warren Buffet is a big player in the reinsurance business. Reinsurance is the insurance of insurance so to speak. Most insurance companies will then insure themselves against large scale losses with the few heavily capitalized companies that can afford to cover such losses. While the details are not quite transparent, I would bet that most of the big bond insurance companies have reinsurance for their bigger potential losses. I would bet that the city of Pittsburgh's bond portfolio represents some of the bigger risk in several bond insurers' portfolios. In fact you can look at the history of the AHERF bankruptcy here in town and see that when it went into Chapter 9 Bankruptcy it did indeed default on bonded debt which then cascaded into a big hit against the excess against loss (i.e. reinsurance) insurance that bond insurer MBIA had with several of the bigger reinsurance companies in the world. If you think all that AHERF miasma is ancient history, finances take a long time to unwind and MBIA only this year was able to settle some of the last issues remaining from the bond insurance-reinsurance claptrap they built for themselves. And if MBIA sounds more familiar to you than a bond insurer should, they are indeed the company that once oddly gave the City of Pittsburgh over $70 million dollars for tax liens that they obviously didn't think though how they would ever be able to liquify other than through sheer extortion... but that is another long story.

So if Buffet's company has reinsurance policies with the city's bond insurers... maybe the ultimate holder of the city's risk portfolio is really the sage of Omaha. Since Warren is such a good investor, does that mean that the city is really a great investment in the end? Maybe, but Warren has made a few mistakes in the past, not the least of which was his big investment in USAir a few bankruptcies ago. That or the namesake of his investment company, the long since shuttered Berkshire-Hathaway manufacturing company which had it's plants closed by Buffet only to retain the name and corporate history.

So the question is does Warren Buffet already own Pittsburgh. Maybe if we rename it Buffet-Burgh we can buy the city back on the cheap? But when you add it all up: the city's fiscal miasma, AHERF, MBIA, tax liens and so on. It's rather amazing that they all tie together in more than trivial ways. Fester has been musing on the potential implications to the City of Pittsburgh's finances if bond insurance rates go up or go away altogether, thus forcing the city to borrow at much higher interest rates. I say flip that logic and ask what impact the city of Pittsburgh's precarious finances could have on the entire bond insurance market and beyond. The City's bonded debt is a drop in the bucket of the entire municipal bond market, and also pretty small part of all the bonded debt out there... but it is probably not an insignificant part of the bonded debt really at risk when you factor in the size of the city's debt and the state of city finances. Are bond insurers in the situation Japanese banks were through the 1990's? Could a hypothetical future city default be the lead-weighted feather that pushes a bad situation over the edge?


Anonymous Anonymous said...

I didnt realise pittsburgh had these debt problems. Ive been looking into getting bonded. myself but I dont think I will need insurance bonds at the minute.

Wednesday, April 30, 2008 4:24:00 AM  

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