Friday, December 21, 2007

Marty Whitman backs Bond insurers - says Ackman is wrong

I'm a big fan of Marty Whitman. He has one of the best track records of any investor and is an expert in insurance and company restructuring.

In this CNBC interview (link below) Whitman says quite bluntly that Ackman is a good salesman but doesn't know how insurance works. Marty says these bond insurers just need capital to survive & he is investing in their shares,he is confident that over the next 3-4 years they should be okay.

As much as I regard Martin Whitman highly, I believe Ackman is right on this one. Given the downgrade to junk of ACA capital recently which effectively prohibits them from writing new business , Ackman certainly looks to have taken first points. Of course there are many more rounds to go.

I think it is possible for one or more of these bond insurers will end up in bankruptcy, either way it is likely given the large amount of subprime exposed business they have written & which is multiples of their shareholder surplus, that they will be forced into heavily diluting their stock. MBIA recently revealed a $8 billion dollar exposure to highly risky CDOs backed by CDOs when it only has $6.4 billion in shareholder equity. How heavy will the dilution be, that is an open question but one can predict its probably going to be considerable and raises the issue of whether an insurer such as MBIA actually has negative book value, if its liaiblities were marked properly.

Marty Whitman does have an advantage over individual investors in that he coud end up brokering deals with these bond insurers to provide convertible debt which would dilutive to other shareholders but would be great for Third Avenue Funds.

One question I keep on asking myself in relation to MBIA & Ambac is this. If the business they were doing, insuring complicated derivatives like CDOs was so compelling and so profitable (as MBIA at one stage declared they were the most profitable company in the S&P 500) why were the smart players such as Buffett & Berkshire Hathaway not there as well? Why was Berkshire not playing the game. Were the economics really that good ? Also you have to ask about the margin of safety of investing in a business that requires a AAA credit rating otherwise its business would be materially damaged. Property and casualty insurers can can suffer downgrades & still operate, bond insurers don't have that luxury.

One area that I believe Berkshire Hathaway could end up getting involved is in providing insurance to municipal bonds that are mostly AAA and have very low risk. If MBIA or Ambac are forced to cut back on this business due their own capital issues, I'm prepared to bet that Buffett will take a good look this municipal bond business. Buffet may even buy municipal bonds for his insurance companies as munis have represented really good value recently given the subprime credit crunch.

Heres the link to Marty Whitman's interview...


Disclosure: I have have no position in securities discussed except Berkshire Hathaway (BRK-B)

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