Buffett Offers Bond Insurers a Hand ... Maybe

What can we do to help the market's struggling bond insurers? Build a bank consortium to back them up? Nah, banks have their own problems. Organize a government bailout? Please! We all know taxpayers won't go for that.

No, when the going gets tough, and you need ridiculous sums of capital, there's just one person to count on: Warren Buffett.

On Tuesday, Buffett's Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) announced that it would offer the three largest bond insurers, Ambac (NYSE: ABK  ) , MBIA (NYSE: MBI  ) , and FGIC, the opportunity to essentially turn over the tax-free municipal portion of their bond insurance portfolio to Berkshire. Buffett's company would receive 1.5 times the unearned premiums the insurers were set to receive if the bonds default -- roughly $9 billion. In return, Berkshire would take on the liability of some $800 billion worth of municipal debt.

Insurance you can count on, for once
If the deal went through, that $800 billion in municipal bonds would be backed by the Fort Knox power of Berkshire's balance sheet and pristine rating -- a prospect that thrills the market. At present, some of those same bonds are trading at lower levels than their uninsured counterparts, simply because so many investors are dumping anything attached to the now-rocky insurers. Talk about tough love, especially this close to Valentine's Day!

This is Buffett's latest move following the recent announcement that he would form a new entity to insure municipal bonds. The aforementioned three insurers previously dominated that market, but amid the huge losses they incurred by insuring near-worthless CDO debt, investors have begun to question how much attention they can devote to the municipal bond market. Buffett, always looking to pounce when the market becomes fearful, stepped in shortly after Ambac got downgraded by Fitch ratings earlier in the year.

Relief, please!
While the deal earned a warm reception from a market dying for good news, this isn't a bailout of the bond insurers by any means. The municipal bond insurance these three companies provide is essentially their only remaining advantage. Without it, they're left holding only the swiftly rotting insurance on CDOs that contain more toxic subprime debt.

Even Buffett isn't denying that this deal benefits bondholders and Berkshire more than the three insurers. "When I go to Saint Peter, I will not present this as some act that should get me in," Buffett quipped. "We're doing this to make money."

Ambac has officially rejected the deal; MBIA and FGIC have yet to publicly respond, but will likely follow suit. While trying to keep their essential AAA credit rating, both Ambac and MBIA have taken steps to raise capital in the past month, showing they're at least attempting to stay afloat and survive on their own terms. Their chances of success remain to be seen, though most observers seem less than optimistic.

More pain to come?
In a live CNBC interview, Buffett also acknowledged he had been approached by other finance companies looking for a bailout, but had rejected all of them. Since last fall, financial-services companies like Countrywide (NYSE: CFC  ) , Citigroup (NYSE: C  ) , Merrill Lynch (NYSE: MER  ) , and Bear Stearns (NYSE: BSC  ) have all raised additional capital after being hit hard by massive writedowns, but Buffett didn't bite.

To date, the only other deal Buffett has made as a result of the shakeout was the 3% stake he purchased in Swiss Re last month. He's made a point of steering clear of anything related to the CDO mess, saying, "I'm not sure anything is going to do much for the CDOs."

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