Failure by design

The markets are rallying on news that billionaire investor Warren Buffett has offered the three largest bond insurers, a plan to reinsure $800 billion in municipal bonds. The three companies are: Ambac Financial Group Inc., MBIA Inc. and Financial Guaranty Insurance Co.

Bond insurers write policies that protect bondholder’s payments in case the bond issuer defaults. Buffett has made it clear he will not invest in the bond insurers, but is offering to insure part of the risk these bond holders took on. The municipal bonds that Buffett has chosen are fairly safe and are not the cause of the current credit crisis. The CDO’s that are causing the bond insurers so much grief lately are not part of Buffett’s plan.

Buffett’s move is more of an act of good faith, helping to restore confidence in the economy and providing the bond insurers with additional revenue. Several bond insurers have seen dramatic drops in share price, such as ACA Capital Holdings (OTC: ACAH). ACAH has seen there share price drop from $15 to $0.65 on credit rating downgrades and losses spurred by higher than expected defaults in the CDO market.

Bond insurers rely heavily on their credit ratings to get new business and the recent troubles in the credit markets have caused several rating agencies to start considering downgrades. A downgrade of a bond insurer is essentially a downgrade of all the bonds issuers that they have covered, and is generally a sign of increased downside risk.

If you liked this article feel free to check some other finance articles here at Thiagoavila.com and at Bluemoat

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