Any get comments from WSO users on why the scheme proposed at the end of this post would or would not work? It seems like municipal issuers could for a cooperative to self-insure to cut out the middle man and still get a lower cost of borrowing. I would also love to hear what kind of trades WSO users investing in municipals on their desks are using to take advantage of the relative mispricing between munis and Treasurys.
http://www.princeofwallstreet.com/2008/03/03/muni…
An Excerpt from the end of the post:
Yet, what The Prince is most interested in right now is the future of insurance for municipal bonds. Is it necessary? Can it be used to achieve a lower cost of borrowing for municipalities, governments, school districts, and the like? First, we have to ask if being in the business of insuring solely Municipal bonds right now is a good business. Warren Buffet seems to think so. He recently launched a bond insurer that would help state and local governments lower their borrowing costs, and possibly lure business from established rivals struggling with failing credit markets. Berkshire Hathaway Assurance Corp guarantees the bonds that cities, counties and states use to finance public works. The new company avoids investing in structured products, such as bonds backed by cash-generating assets such as mortgages and credit-card receipts. Berkshire Hathaway Assurance Corp., or BHAC, has effectively been taking market share from incumbents such as Ambac and MBIA which have been struggling to keep their triple-A credit ratings. In recent days, rating agencies have bestowed triple-A ratings on municipal bonds insured by the new Berkshire venture, months before competitors and some analysts predicted. Last Friday, Maryland's insurance department granted BHAC a license to do business in that state. The company has already guaranteed more than 100 municipal-bond offerings, including debt issued by New York City, where it received its first license. The Prince would have to agree that business is good for an insurer with a strong balance sheet, that isn't trying to raise new capital, and is not taking a six month hiatus from issuing new paper at the behest of the rating agencies.
If we accept as a first premise that issuing bonds with insurance issued by a well capitalized insurer does lower borrowing costs, then The Prince thinks he sees a better way to lower borrowing costs. While The Prince is not an expert on this topic, he would love to get some feedback on this idea. Why do we not see the big issuers of municipal bonds i.e. the Port Authority of New York and New Jersey, the State of California, tollways, etc., forming a coop together to issue insurance. This coop would take the form of a public "utility". Why give all the rents to Warren Buffet's insurer or another insurer when the issuers can effectively cut the middle man out. In theory, if we could get the top 100 issuers of municipal bonds to contribute capital to an entity controlled by the contributors that entity could then provide insurance to the members at a lower cost than private insurers. The contributions would serve as the assets that would insure the bonds from default. The effective borrowing costs for issuers would have to decline under this cooperative self-insurance scheme. Under this scheme Tom Dresslar, spokesman for California state Treasurer Bill Lockyer, wouldn't have to say "we're prepared for higher rates than we've paid in the past." California could buy insurance from this cooperative public "utility" entity which would lower the State of California's cost of borrowing even when you consider the fact that California had to buy shares in the cooperative entity. The market may be pricing insurance from unsound insurers as if it doesn't exist right now but they could not ignore insurance issued by a well capitalized public "utility" like the one The Prince has outlined above. If nothing else there would be serious savings for those that still want to issue debt that has insurance. This is the case, because Before the bond-insurer crisis, bond insurers charged about 30% of the interest-rate savings an issuer would get. This has climbed to about 80% or 90% as the bond insurers try to extract as much premium as possible. For the issuers, though, that has reduced the value of the coverage.
If all the major issuers setup the scheme The Prince has discussed above, not only could they save the premium that insurers extract, but the value of their bonds' insurance would not be subject to the poor business decisions of a third party bond insurer choosing to insure riskier non-municipal instruments. All the questions in the market like those intoned by California's deputy state treasurer, Paul Rosenstiel, "as to the value of insurance and whether it would save us money" would be silenced. Please, to those who are more knowledgeable about this than The Prince, tell him why his scheme above would not work. He wants to believe that a scheme as this simple can't work in our time of sophisticated and evolved finance.
