The Case for Eliminating Muni Bond Insurers, Part II

While people are still giddy at the goofy prospect of Warren Buffett buying pennies from bond insurers at a tenth of a cent each — oooooooh! — it’s time to insert more facts into the discussion. Here, from a recent presentation by Bill Ackman, is what the muni bond insurance really costs, as opposed to the pitch that it saves investors money:



  1. Muni insurers haven’t cost money. Rating agencies have. Insurance can and is only allowed to be used when it provides net lower interest cost to the municipality versus similar but un-insured debt. Hence, investors paid more for insured debt than un-insured debt; a portion of that money going to the insurers, a portion to the municipal. So why did investors desire that?
    The problem is that municipals should have much higher ratings. Rating agencies have admitted that and Ackman points it out in his pitch. Rating agencies were simply arbitraging that game; the only reason a lightly capitalized niche insurance company could have a “AAA” is that the underlying credit was “AAA” to begin with. Seriously, ABK/MBI underwrote to a (gulp) ZERO LOSS standard! With munis underrated and many investors desiring a “AAA”, insurers played the game. In their absense, now Buffet will try to do so again. MBI/ABK responded to the market and incentives, kudos to them for being there first.
    Also, there are over 50,000 and maybe over 60,000 unique credits in the municipal market (think small town/school districts etc.) issuing only $5m-10m each few years. It is difficult to track all those credits and monolines homogenized the market, adding perceived liquidity but not necessarily credit protection. To some degree, there are state agencies/programs to homogenize that credit as well, but alas they are underrated because the state itself is underrated.
    Now why do Moodys/S&P/Fitch continue to underrate municipals? I do not blame investors for desiring AAA credits, nor MBI/ABK/now Buffet for arbitraging it, I blame Moodys/S&P/Fitch for not rating them properly and silly rules relying on rating agencies instead of good old fashion work.
    Now, if Ackman is hiring, I’m available.