Bonding With Buffett

The oracle had a vision. Not the oracle at Delphi --the one in Omaha.

Bond insurers have been pummeled by the recent credit crisis, and companies like Ambac (NYSE: ABK  ) and MBIA (NYSE: MBI  ) face the prospect of losing their top-notch ratings.

That means higher costs for cities and municipalities (read "taxpayers"), which will be able to use the insurers' ratings to obtain lower rates for themselves on the bonds they issue.

Warren Buffett sees an opportunity there and is, well, seizing it. He's going to start his own bond insurer using Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) sterling credit rating, and will charge municipalities a high fee to access it.

If nothing else, Warren Buffett knows how to maximize his profit potential. Some $2.4 trillion -- yes, that's with a TR -- has been guaranteed by bond insurers, most of which has been issued by various levels of government. Over the past three decades there have been few defaults, meaning it's a profitable business with little downside risk. BusinessWeek once termed municipal bond insurance "an almost perfect money machine."

Yet the bonds do carry risk, as the bankruptcy of Orange County, Calif., in the 1990s showed. Buffett has long felt that the premiums insurers charged were too low to justify entry. But now the ratings agencies are taking a harder look at just what their ratings mean, and Buffett sees his chance.

Cities and states are likely to jump at the opportunity to pay Berkshire's higher fees, because it will ultimately save them money on the money they borrow. Bond insurers themselves would likely be charging more, anyway, to bolster their own finances; Ambac, MBIA, and PMI Group's (NYSE: PMI  ) Financial Guaranty Insurance were all placed on a ratings downgrade watch by Moody's (NYSE: MCO  ) .

Berkshire Hathaway Assurance opens for business today in New York. It hopes to spread to all 50 states, though it will examine each case individually. Typical of Buffett, his insurer will stick with plain-vanilla insurance and not venture into the more creative structured-finance business that sent the industry into a tailspin.

Since the last thing the bond insurers need now is a competitor with a triple-A credit rating coming in to steal business from them, this looks like a classic Buffett investment decision to capitalize on a distressed industry.

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