From: Reuters
Published March 12, 2008 02:30 PM

Berkshire's Jain: Risk of insuring muni bonds rising

By Dena Aubin and Patrick Rucker

NEW YORK/WASHINGTON (Reuters) - Troubles in Jefferson County, Alabama, and Vallejo, California, could be the "tip of the iceberg," as economic woes raise the risk of insuring municipal bonds, a Berkshire Hathaway official said on Wednesday.

Moreover, if the rating agencies level the playing field in terms of how they rate municipal versus corporate obligations, "there will be little need for a financial guaranty insurance marketplace as we know it," Ajit Jain, head of Berkshire's <BRKa.N> new bond insurance unit, said in prepared testimony to a U.S. House of Representatives hearing on municipal bonds.

Rating agencies have recently come under criticism for using tougher standards for rating municipal bonds than they do for corporate bonds, with several state treasurers calling for agencies to recalibrate their system.

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U.S. Rep. Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee, on Tuesday said if the same scale were used for both markets, most muni bonds would have such high ratings they would not need insurance.

"While we are writing business at pricing levels that are economically attractive to us, I remain very concerned about the long-term viability of this business in general and for us in particular," said Jain, whose company just started insuring municipal bonds in January as other bond insurers faltered.

While there have been few municipal defaults over the past 50 years, Jain said he is amazed that many experts consider muni bond insurance almost a zero-loss business.

The threat of debt defaults in Jefferson County and Vallejo both highlight the increasing risk of insuring municipal bonds as state and local governments come under pressure from a weakening economy, he said.

'PROMISE TO PAY' QUESTIONED

Bondholders saw the value of their investments plummet this year and issuers saw their borrowing costs skyrocket on fears that existing insurers, including leaders MBIA Inc <MBI.N> and Ambac Financial Group <ABK.N> may lose their top "AAA" ratings.

"With insured muni bonds selling at higher yields than corresponding uninsured bonds, buyers have every right to question the value of the bond insurers' promise to pay," Jain said in testimony obtained by Reuters.

Moreover, efforts to split insurers' business into a "good bank/bad bank" will reinforce concerns about the integrity of insurance and cause permanent damage to the business, he said.

Even if insurers maintain their ratings, they will have to engage in price wars to win business, assuring a bleak future for the industry, he said.

Berkshire had been considering entering the muni bond insurance business for almost 20 years but thought the premiums were underpriced for the risk, Jain said.

That assessment began to change radically in October with the subprime crisis and awareness of financial losses it would cause, he said.

Berkshire expected that pricing going forward would reflect expected losses plus a "reasonable return" to the insurer, he said. They also expected that existing industry leaders could have their franchises "mortally wounded" by the subprime and structured finance exposures that they had taken on, he said.

Berkshire was asked to enter the business by New York insurance regulators who were trying to resolve a crisis brought on by struggling insurers.

(Reporting by Dena Aubin and Anastasija Johnson in New York and Patrick Rucker in Washington; )

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