Buffett's Big Muni Bond Offer: CNBC Interview Transcript (Part 1)
This morning on CNBC's Squawk Box, Warren Buffett publicly revealed for the first time that he has offered to reinsure $800 billion in municipal bondsnow covered by the troubled insurers MBIA, Ambac and FGIC.
That would effectively give those bonds a AAA credit rating. So far, he says one insurer has turned him down and he hasn't heard from the other two.
This is a transcript of this morning's live phone conversation:
Becky Quick: We know Warren that you've already put a plan out where you are, in fact, a bond insurer yourself. You have a new company that's doing that. But beyond that, Ambac, FGIC and MBIA, they all have some significant problems. What do you think needs to be done?
Warren Buffett: Well, last Wednesday, as you know we have formed a new bond insurer. And last Wednesday, Berkshire Hathaway made a firm offer to the three largest bond insurers, who in aggregate I think, insure about 800 billion (dollars) of tax exempt bonds.
And what we said we would do is, and we gave a copy of this, of course, to the Superintendent of Insurance of New York. We said we would form, we would add to our company's resources five billion dollars. That five billion dollars in the new insurance company, we would pledge that there would be no dividends or any kind of distributions or management fees taken out of that for ten years, so all the earnings of that company would be retained to build up the claims-paying ability.
And we offered to take over the liabilities for the whole $800 billion of these three companies for a premium that would be equal to, essentially, one-and-a-half times the remaining premium left over the life of the bonds. They have what they call an 'unearned premium reserve' which reflects the original premium less the amount that's been proportionately earned. And we said, for one-and-a-half times that amount, we would take away all of their liabilities so that the $800 billion in bonds would carry a real triple-A insurance, and would sell in the market as if it had real triple-A insurance. Whereas now the bonds sell at significant discounts.
And we provided additionally that if they felt that this premium was too high or that they could do better that for thirty days, they would have the backstop of our offer which would be totally firm, and if they came up with anything better for themselves and for the holders of their insured bonds, that for a break-up fee of one-and-a-half percent of the premium, that they could go and take the other deal. So that the world would know that, one way or the other, that that the municipal bond insurance problem was behind it. It would be either with our offer or some other offer that they went out and obtained.
So, we put that out there to the three largest insurers and if they should decide to take it, eight-hundred billion of bonds that are now selling as if they were uninsured, or even in some cases a little worse. They're probably selling on balance maybe 5 percent below where would sell for if the insurance was regarded as good, which is 40 billion on 800 billion. We will see what happens.
Becky: Have you gotten a response from any of the three bond insurers that you sent this letter out to, Mr. Buffett?
Buffett: As of last night, we were turned down by one and we hadn't heard from the other two, so it didn't sound like they were leaping for the door to say 'yes' to us.
Becky: You might imagine they weren't leaping to the door because if they agree to do this that still leaves the entire portfolio of everything else that's out there, the CDOs and the rest of that. There are some people who would probably think that this would leave those insurers in a pretty tough position, if they gave you the business that's seen as the safe business, and were left with the rest of it.
Buffett: Well, they would still have substantial book capital. But how deep that problem is with the CDOs is and other things they've done, we can't figure it out. What this does, is it means that the municipals, in effect, get taken off the table and they know they're good and you've got 800 billion of those that are good. It doesn't do anything for the CDOs, but I'm not sure anything is going to do much for the CDOs. We'll just have to find out how that plays out.
If it's left to its natural course, and the CDOs prove to be a disaster, because there will be a disaster earlier, they will use up the funds of these companies, and in effect, the municipals stand at the back of the line. So, our system puts the municipals at the front of the line. What's going on now leaves the municipals at the back of the line because the funds will get depleted for all of these other types of insurance before they get to the municipals in very large part.
Becky: Obviously, the municipal bond insurance is a big issue for the Superintendent of New York, to whom you also said you sent the letter to. But does the Superintendent and other regulators, do they have any power to try and force these bond insurers to take that offer?
Buffett: I don't think they probably do unless they should take over these companies at some point. I think they can certainly prevent them, the insurers, from paying dividends upstairs to their parent companies, which could cause a fair amount of trouble for some of them.
I should add the insurance departments, particularly the Superintendent of Insurance in New York, Eric Dinallo, they've been very cooperative and put forth a lot of energy into trying to find a solution for this. They want to find a solution for the municipal bond insurers. They want it for the $800 billion in the case of these three companies that are out there. But they also want it to open up the issuance of municipal finance.
Right now, the standard guarantee is not only worth nothing. We've actually bought, or, we see bonds trading that are insured that are selling at lower prices than their uninsured counterparts, just because there's been an unusual supply and demand situation. So the insurance in the market is presently not doing the bondholders a bit of good, and in fact in some cases it's even penalizing below the price of other bonds.
I should mention the price we're offering here is kind of interesting. The one-and-a-half percent, which, ah, the one-and-a-half times their original premium, we're receiving in the market right now, our company is receiving double the premiums that were originally charged just to stand behind the present bond insurers in case they don't pay. So for being a second-to-pay, we're getting twice the premium that they received to be first-to-pay, which says something about the market.
Carl Quintanilla: Warren, it's Carl. Can you tell us which has said no, of the three? (Warren chuckles.) And another question Warren, what would a scenario look like in which some of these bonds lost triple-A. Could the markets, the broader markets withstand that?
Buffett: Well, in effect you're seeing a market where they've lost their triple-A. They're trading as if they're uninsured now. Now as I understand it, if they formally lost their triple-A, there are a number of institutions that have to sell them. So, you might see an even greater, well you would see a greater supply hit the market. So you could easily have a disruption for awhile that would be reflected by this outpouring of people that would now find those bonds ineligible to own. You've already seen the market effects to some degree but you haven't seen an absolute forced sale where a mutual fund or a bank trust department or somebody that says we're only going to own triple-As, ah, would have to sell them because the triple-A formally went away. In the market, the triple-A has gone away a long time ago.
Carl: Who has been the stick in the mud?
Buffett: (Laughs loudly.) Well, I'll, maybe they'll call in after the show and tell you. (Laughter.)
Joe Kernen: Mr. Buffett, it's Joe. Good to talk to you. Last time you were on, we made a big deal out of, I don't know, you were actually admitted, 'Yeah, I've been approached by one of those financial deals.' I'm going to approach it differently this time. I assume you have been approached about every single, solitary, one of these deals that we've seen get done. That's probably true, isn't it?
Buffett: It's close to true.
Joe: Close to true. All right. Soveriegn funds, all of that stuff?
Joe: You've turned down every single, solitary one of the them, and I think that is very, very noteworthy. And I just want to know why? Because some of these things are selling at a 50 to 60 percent discount from where they were, and you like things when they're cheap, unless they're getting a lot cheaper. So you must be pretty darn bearish about the prospects for a lot of these financials.
Buffett: Well, or there are other things that I feel I understand better, where I think that they're cheap. But because something is down 50 percent from where it was does not necessarily mean it's cheap. It's something that you look at, but, ah. For one thing, we try to stick with things that we understand, and as you've noticed with some of these deals, the first news is not necessarily the last news.
Joe: Yeah, comment on AIG. What did you think of that yesterday?
Buffett: Well, I think it's very, very, very tough to evaluate a lot of these securities. You know, sometime back I called them, derivatives, 'weapons of mass destruction.' I probably should have called them 'weapons of selected destruction.' But it's been pretty massive in some cases.
Joe: Do you know, is General Re, is there anything there that worries you? Then I would say you've played beautifully, carpet, Mo, things like that, any of those businesses really affected right now in a way that's disappointing to you?
Buffett: No, not disappointing, but I would say that carpet, brick, insulation, our real-estate brokerage operations, anything that has anything with housing, was down last year and continues down. Now that's not disappointing because you know that if you own anything connected with new house sales, that periodically, you know, you're going to feel it. But they have the most competitive position. They're strong and well-managed companies, but their earnings, anything we have that touched the new home market last year had down earnings and this year is going to have down earnings.
Joe: How about General Re?
Buffett: Well, General Re actually did quite well last year. In fact, it may have had the best year in its history. But, none of our companies own the CDOs or that sort of thing.
Jack Bogle: Hey, Warren. It's (Squawk Box guest host) Jack Bogle. How are you this morning? Good to be in the same show with you.
Buffett: Well, listen, I'm a huge fan of your books, as you know.
Bogle: We're a mutual admiration society.
Buffett: Yeah, right!
Bogle: Let me just ask you one question on these bond insurers. About 25 to 30 percent of their portfolios outside of the municipal areas, isn't that correct?
Buffett: That's probably correct. They, it's kinda interesting what happened, Jack. It would fit in with some of your theories. They originally started out being pure, municipal bond insurers. And then they sort of did what Mae West said, 'I was Snow White but I drifted.' (Laughter.) And what happened was, that the prices for municipal bond insurance went down and these companies, probably to satisfy Wall Street's desire for increasing earnings when the price of their product, their basic product, went down, and what they knew best, they went out to get into riskier products which paid higher premiums and it made their earnings look better for awhile. But, they, you know, it created this mess. It's interesting, even the rating agencies in rating these companies would ask them to give them projections that showed ever-increasing earnings to get their triple-A. So you had the wrong incentives and you know better than anybody else, Jack, that wrong incentives produce wrong results.
Bogle: Well, yeah, and I think the rating agencies have an awful lot to answer for here. You could say they're in cooperation with the issuers. I would say they're in collusion with the issuers.
Buffett: Well, when a company issues a 14 percent bond when U.S. Treasuries are below 4 percent and it's rated triple-A, we've now seen the cow jumping over the moon.
Becky: Warren, there are some people who would say if the bond insurers took you up on this deal and agreed to pay one-point-five times premium for this, on the good part of their business, they would, in effect, be signing their own death warrant. Why would any of these guys agree to this?
Buffett: Well, some of them say, still, that they're going to do OK, or reasonably OK, on their CDOs. They will be releasing regulatory capital that will be fully equal to the premium that they would pay to us. So they are as capable as before of doing business and maybe they can attract more capital and maybe they can't, but the one thing that the world will know is that 800 billion dollars of tax-exempt bonds are now triple-A again.
END OF PART ONE OF BUFFETT TRANSCRIPT
PART TWO WILL BE POSTED SEPARATELY AS IT BECOMES AVAILABLE
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