Tuesday, 12 Feb 2008
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 bonds now 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 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.
New York State Insurance Superintendent Eric Dinallo
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.Becky: How is the bond insurance business going so far, the one that you started up at the end of last year?
Buffett: Well, we've done a few things, and as I mentioned the other day, for example, we were paid two percent on a 50 million dollar deal, we were paid a two percent premium, that's a million dollars, and all we did on that was, we backed up the present bond insurer, which is rated triple-A, we backed them up in case they don't pay. So, we're getting a premium of two percent for something they charged originally less than one percent for, and they still have to pay and all we have to do is pay if they don't pay. So, it just shows you what the state of the market is now, and the fact, and it also shows you that the offer we made, I think, in terms of present market prices for insurance, is really on the low side.
Becky: In other news this morning, there's talk that six major mortgage lenders are doing something that they hope will prop up the housing market. They're talking about their plan to halt the foreclosure process, not only in subprime, but in some of the prime issues as well. One of the banks involved is Wells Fargo [WFC 17.22 2.56 (+17.46%) ], which obviously you hold a stake in. What do you think about this plan?
Buffett: Well, I think anything Wells Fargo comes up with usually makes sense, so I, ah. It's always in the interest, it's almost always in the interest, of a mortgage lender to keep the borrower in the house as long as they've got a good faith borrower who's doing his best to pay what they can. It's a terrible thing. You've got an empty house, the value of it shrinks pretty fast. So they're probably acting in their own self-interest, which Adam Smith would be proud to know, they're also in the social interest as well.
Joe: Once again, your foresight, not just investments, but instead of just backing one or the other, Hillary or Barack Obama you said, 'I think either one of them would be great. I'd help either one of them raise money.' Can you comment on what seems to be a shifting tide at this point, Warren?
Buffett: Well, it's probably the most interesting election I've ever seen. And even though you're going to live a lot longer than I will, it's probably going to be the most interesting election you'll ever see.
Carl: I can't imagine you expected it to go this far?
Buffett: Well, you've got two outstanding candidates and you've got very enthusiastic people behind both and both have big money-raising possibilities and potential. It's going to go down to the wire, I think.
Joe: Just shifting gears again, you know, whenever we have you on, unless I get a really, really hard wrap that we gotta go, I'll just come up with questions.
Carl: Pull up a chair, Warren.
Joe: Yeah, grab a chair. But we have seen some smart people say we have dug ourselves such a hole, with all these, you know, current account, whatever deficit that you want to look at, that if we do go into a slow patch here that this could be either a real doozy, like maybe (former Treasury Secretary) Larry Summers or (billionaire investor George) Soros or someone like that said. Or there are other people who think that we've now learned how to manage business cycles and that the Fed can help. Do you think we'll ever have anything like we had back, when you, you know, back in the 30s, Mr. Buffett? Could it just get really nasty? Could that happen this time around? Do you have that feeling?
Buffett: It's a low probability, but, you never know what's going to happen, Joe. You know, the variables that go into any different economic scenario are always changing, they're relative weight changes. Human behavior doesn't change much, but, I've never made a dime predicting economic activity. We just try to buy businesses we understand at sensible prices. So, I know you don't want any advice from me on your golf game because I shoot around 110. And I really shoot about 110 in economic analysis, too, it's just not as easy to spot it.
Joe: Yeah, you've got a handicap. For awhile last week, it looked like you were calling for some sort of calamity with the "worthless" vs. "worth less" ..
Carl: Yeah, way to kill the dollar, Warren.
Joe: I figure if the dollar did go to zero, (laughter), that that would probably be some type of financial calamity. (Laughter). I mean, you've got to be careful with the media, Warren.
Buffett: (Laughing.) Yeah, I have to be very careful how I phrase things.
Carl: I don't know if there was a way around that one. That must have given you at least some sort of chuckle, right?
Buffett: (Laughing.) Well, it was entertaining. I still wanted to call and get it corrected pretty damn fast.
Joe: Yeah, it wouldn't be that funny with a run on banks and if all the stock markets crashed around .. yeah, that was a pretty ..
Becky: In all seriousness, though, Warren. On the dollar, when you start looking at it, would you be in a position where you'd be betting against the dollar again?
Buffett: Well, as we try to develop a little more in the way of foreign earnings at Berkshire, we'll move a little in that direction. We'll always be, you know, the majority of Berkshire's money, and my money, will always be tied to the U.S. dollar. But I do not think the future of the U.S. dollar is great as long as we keep following the policies that are almost certain to weaken it over time.
Joe: How has the, in this slowdown, Warren, the NetJets business? Have you seen any slowdown at all in that area? I figure that they're so many rich people that you haven't at all, I guess.
Buffett: The super-rich have not felt this. It's interesting, because I do get those figures on a very frequent basis. I'm curious about it. In December, it was a record. Marquis sells these cards that entitle people to use NetJets, and on the Friday before Christmas I think they sold 61 in one day alone. And the starting price for those is over one-hundred thousand, and we set a record in December. January was strong. So far, you haven't seen anything among the super-wealthy.
Now we see it at our jewelry stores, we see it at our furniture stores, that the middle-class, and the upper-middle-class, you know, they're struggling. And that business is slow but the super-rich seem to be flying along.
Bogle: As always, Warren, as always.
Carl: Warren, a question from some of our friends in the bond pits in Chicago. They want to ask: Given ratings right now, is it possible that some of the insurers could do a swap where you issue new paper with new ratings on the muni front? Is that a possibility for them?
Buffett: Well, I don't, ah. In effect, they would be getting new paper if they took up our offer. We would reinsure these three that we made the offer to and at that point it would have a Berkshire Hathaway triple-A on that paper. And people are paying us two percent just to get the guarantee behind them, and obviously in the market they feel it makes the value of that bond even more than that after paying the premium. So, I think that, it's the efficient way to do it. I mean, it can solve it in one stroke of a pen.
We're doing it one-by-one now, and we're getting paid more for doing it on a one-by-one basis, but this would just eliminate one major cloud from the market.
Becky: Still, you're not doing this out of the kindness of your heart, right, Warren?
Buffett: No, no, no. This is, when I go to Saint Peter I will not present this as some act that should entitle me to get in. No, we're doing this to, we're doing this to make money. And, you know, if you put up five billion, we think we ought to make some money. But this, I did not dream this up in one of my pro bono moments.
Becky: Warren, if you had to put money on it, would you think that any of these three major bond insurers would actually take you up on it? I realize you have one that's turned you down so far.
Buffett: Yeah, it doesn't look like it, Becky, but in the end what they can do is they could take us up on it and then have a month to come up with a better deal, and it would cost them a fairly modest break-up fee and they would know that at the end of the month they'd have a solution. And maybe they'd have a lot better solution.
Carl: I like asking you Warren, where you think stocks are priced right now, just to listen to the new inventive ways you come up to dance around the question, but we'd be remiss if we didn't ask. Where, or how, do you think stocks are priced right now?
Buffett: I, this is not a prediction of where they go, but I would say they're sort of, and again this is not a big field of expertise for me, but the things I look at seem to me like they're priced in the general range of fair value. They're not cheap, they're not over-priced. But you've got to look at them one-by-one. But as I look at the things, you know, dozens of stocks that I look at, they seem like they're about right considering all the variables.
I do not put into my pricing a lot of thought about what the economy will do in the next year. I really think about what the businesses are likely to do over the next ten years.
Bogle: Warren, I know you've said many times that you look at stocks through the magnifying glass of corporate profits as a percent of GDP.
Bogle: And they're at an all-time high, or were at an all-time high ..
Buffett: Yeah, you're right. They've been at an all-time high, Jack.
Bogle: And the norm is about six. Do you look for a little regression to the mean there?
Buffett: I would think there almost has to be over time
Bogle: That's what I would think.
Buffett: They've been, corporate profits have been through the roof, and partly helped by low effective corporate tax rates for many companies. And, if I had to bet, I would bet real money that over the next ten years they'll average less than they've been averaging currently as a percentage of GDP.
Bogle: Yeah, I agree with you on that.
Joe: You probably, here we go again, you probably even saw Countrywide [CFC 48.5 0.25 (+0.52%) ], I would imagine, Mr. Buffett and then Bank of America [BAC 7.67 1.40 (+22.33%) ] is going to end up there. Do you think that was a good deal for Bank of America?
Buffett: Well, I think they won't know the answer to that for three of four years. I mean, they know they're buying into lots of problems, but they're buying at a price that reflects a lot of problems. Now, whether the problems turn out to be bigger than that price discount they built into the deal, you know, who knows? They did have a chance to take over the largest servicer, and perhaps originator, of mortgages in the country and ..
Joe: You had the same chance.
Buffett: Well, some deals are too complicated for me. I like simple things. The nice thing, Joe, about the investment business is there's no 'degree of difficulty' factor.
Joe: That's right.
Buffett: If you're in Olympic diving, you have to do some very complicated dive in order to get points. But in the investment business, you get paid as much for stepping over a one-foot bar as you do for jumping over a seven-foot bar.
Joe: You think that there are any signs that commodities are in a bubble right now, or does this all make sense?
Buffett: Well, commodities are not my game. But to a small extent, that reflects what's been happening to the dollar. But, there's also been a huge commodities boom measured in terms of any currency.
Joe: We always ask for our Squawk jet and you always send See's Candies. You know, under twenty-five dollar's worth. Carl is happy with See's. I just figured out a compromise when you mentioned one of those cards.
Buffett: You're thinking of the Marquis card, no doubt?
Joe: I'm thinking about the Marquis card. That's not a jet and it's not See's Candies.
Carl: more and more of the toffee. I'll take more of the toffee. (Laughter.)
Buffett: Joe, I would suggest you get a taste for candy. (Laughter.)
Becky: Hey, Warren.
Bogle: I'll take the jet, Warren. (Laughter.)
Becky: What do you think about Bank of America going into the Dow Jones Industrial Average? That makes the fifth Dow component that's a financial. We're still talking about an industrial average, right?
Buffett: Yeah, well, (laughs), I guess they've broadened the definition of an industrial. You know, they used to have, for many years, the anomaly in the Dow Jones average was AT&T. It was there for a long time, and of course, it was a utility, so they show a certain amount of flexibility in terms of their lexicon over there at Dow Jones.
Becky: Well, Warren, I want to thank you very much for calling in today and giving us the details on what you've proposed to do with the bond insurers. I know you have a plane to catch, but thank you again for calling in.
Joe: Are you flying commercial today, Warren?
Buffett: (Laughing.) When I fly commercial, you'll know I'm broke. (Laughter.)
Joe: That's what I said, your last in-flight movie, I believe, was Casablanca when it was actually running.
Buffett: It was actually the previews to Casablanca.
Joe: The previews to Casablanca.
Carl: That's tough. When they edit the Chaplin movies for planes.
Buffett: No, I go back to the silent movies in the planes.
Becky: Hey, Warren, thank you very much today and have a safe flight.
Buffett: OK, thanks.
Bogle: Take care, Warren.
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