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Berkowitz Betting on MBIA Survival as ‘Hated’ Financials Revive


dcollon
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I still don't get it . . .

 

first question: do you have enough industry insight to sit on the board of White Mountains? Second: Are you intimately familiar with the business of insuring munis? Third: Have you poured over MBIA recent SEC documents for days on end and hired consultants do a forensic analysis of the accounting? NO?

 

take it easy there Peter . . . rough day?

 

I have nothing but respect for Bruce Berkowitz, I just don't understand these investments that he has made.  I have followed most of his investments and when he has spoken about them I have found his analysis to be very insightful.  However, with AIG, MBIA, MS etc. I have a hard time understanding what he sees there.  Maybe I am blinded by hatred for financials or biased because these companies needed to be saved from death with taxpayer money a few months ago. This is why I said "I still don't get it . . ." rather than "Bruce Berkowitz is an idiot, who here will defend his honor?"

 

Smart people don't generally get stupid overnight and Bruce has a lot more experience and resources than I do so I would assume that this will somehow work out for him, I just don't understand how . . . from where I'm standing it looks like MBIA and AIG are insolvent and MS seems to have lost a good deal of franchise value. I was hoping someone on the board might also like these investments or have some insight into Bruce's thinking beyond his brief public comments.

 

Considering that AIG is owned and propped up by the government right now, I think being a member of congress would give you more insight into its ultimate value than being on the board of WTM.  WTM is a great company, but that doesn't make its board members experts on the value of AIG. I would say that I'm pretty familiar with the business of insuring munis (we haven't been intimate yet though). I understand that even defaulted munis require very little upfront cashflow from the insurer, but MBIA is arguably bankrupt - maybe you should take a look at Marty Whitman's lawsuit against them for the other side of the argument. Warren Buffett is arguably an expert in insuring Munis and he decided to get out of the business. I don't understand why Berkowitz is investing in a company that could be insolvent pending a serious lawsuit, in a business Warren Buffett won't touch, but again, this is probably a failure to understand on my part - I'm just curious what Berkowitz knows or understands that I don't.

 

Do you have anything to say on the merits of these investments? NO?

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MBIA (and ambac) committed fraudulent conveyance through its transact to separate its guarantees into "muni" and "structured credit."  MBIA under capitalized the structured side (non-recourse to parentco), to the benefit of muni bondholders and MBIA shareholders but to the detriment (I believe illegally) to holders of structured bonds guaranteed by MBIA.

 

This good bank/bad bank structure was approved by the New York Insurance Commissioner, but they are being sued by all of the creditors who had guarantees from MBIA on CDO's ect. 

 

The only reason for MBIA's continued survival is because of this transaction...who knows if justice will ever been served in the court room.

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I still don't get it . . .

 

first question: do you have enough industry insight to sit on the board of White Mountains? Second: Are you intimately familiar with the business of insuring munis? Third: Have you poured over MBIA recent SEC documents for days on end and hired consultants do a forensic analysis of the accounting? NO?

 

take it easy there Peter . . . rough day?

 

I have nothing but respect for Bruce Berkowitz, I just don't understand these investments that he has made.  I have followed most of his investments and when he has spoken about them I have found his analysis to be very insightful.  However, with AIG, MBIA, MS etc. I have a hard time understanding what he sees there.  Maybe I am blinded by hatred for financials or biased because these companies needed to be saved from death with taxpayer money a few months ago. This is why I said "I still don't get it . . ." rather than "Bruce Berkowitz is an idiot, who here will defend his honor?"

 

Smart people don't generally get stupid overnight and Bruce has a lot more experience and resources than I do so I would assume that this will somehow work out for him, I just don't understand how . . . from where I'm standing it looks like MBIA and AIG are insolvent and MS seems to have lost a good deal of franchise value. I was hoping someone on the board might also like these investments or have some insight into Bruce's thinking beyond his brief public comments.

 

Considering that AIG is owned and propped up by the government right now, I think being a member of congress would give you more insight into its ultimate value than being on the board of WTM.  WTM is a great company, but that doesn't make its board members experts on the value of AIG. I would say that I'm pretty familiar with the business of insuring munis (we haven't been intimate yet though). I understand that even defaulted munis require very little upfront cashflow from the insurer, but MBIA is arguably bankrupt - maybe you should take a look at Marty Whitman's lawsuit against them for the other side of the argument. Warren Buffett is arguably an expert in insuring Munis and he decided to get out of the business. I don't understand why Berkowitz is investing in a company that could be insolvent pending a serious lawsuit, in a business Warren Buffett won't touch, but again, this is probably a failure to understand on my part - I'm just curious what Berkowitz knows or understands that I don't.

 

Do you have anything to say on the merits of these investments? NO?

 

Thanks you just perfectly captured my thoughts and saved me 10 minutes from having to type all that.

I hold Bruce B in high regard, and he is one of the few managers I have recommended or would let manage my money should I get lazy, but I dont understand his recent positions / investments. From Joe to Citi to AIG to Morgan Stanley to now MBIA.

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I understand that even defaulted munis require very little upfront cashflow from the insurer, but MBIA is arguably bankrupt - maybe you should take a look at Marty Whitman's lawsuit against them for the other side of the argument. Warren Buffett is arguably an expert in insuring Munis and he decided to get out of the business. I don't understand why Berkowitz is investing in a company that could be insolvent pending a serious lawsuit, in a business Warren Buffett won't touch, but again, this is probably a failure to understand on my part - I'm just curious what Berkowitz knows or understands that I don't.

 

T-bone, why do you think that MBIA is arguably bankrupt?  MBIA appears to be paying off liabilities when they come due, so there is no need to go into bankruptcy.  Perhaps you're talking about balance sheet insolvency as opposed to cash flow insolvency? 

 

The fraudulent transfer suit is related to the asset stripping "transformation" that watsa_is_a_randian_hero refers to in his post.  Marty Whitman thought that his bond deal was safe and cheap before the municipal insurance co was cordoned off from the structure finance part of the company.  (I think I will try to read the lawsuit if I get the time -- fascinating stuff.)

 

The real questions are: (1) how much is MBIA worth in runoff mode, and (2) how much is MBIA worth if the creditors' lawsuit goes away and the municipal insurance co is able to start writing new business? 

 

A side question: does Bruce Berkowitz want MBIA to issue equity to Fairholme in order to pay for a settlement with the creditors?  The WSJ article indicated that Berkowitz wants to help recapitalize the company.

 

These questions are too hard for me or for most people on this board to figure out.  Figuring out how "adjusted book value" approximates runoff value is something that people like Berkowitz, Whitman, Buffett, and Wilbur Ross can do. 

 

What intrigues me about this space is how Bruce Berkowitz, Martin Whitman, Warren Buffett, and Wilbur Ross all decided to get involved with these muni financial guarantors over the last couple of years.  That should tell you that insuring against municipal defaults is a pretty good business over the long run.  It's also a socially useful business.

 

As far as I know, Assured Guaranty (AGO), backed by Wilbur Ross, is dominating the market right now, which I would think would be a "hard market" since we're all scared about municipal defaults.  I'm not sure why BRK pulled out.  I think it might have to do with BRK losing its AAA rating.

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txlaw,

 

I think the fact that Whitman, Berkowitz and Buffett are on different sides of this argument suggests to me that these stocks go in the too hard pile - at least for me.  I think they are really a political question. Whitman recapitalized MBIA and the government allowed the bond insurer to steal the money from the parent for political reasons. This is what the fraudelent conveyance lawsuit is about.  AIG went bankrupt and the government kept them alive, which is the only reason they have a market cap right now.

 

I readily admit, I am a US taxpayer, and maybe I am too upset about these situations to see the investment merits clearly. But if the rule of law still applies, I don't think these are good investments. Whitman should win his lawsuit in any reasonable courtroom . . . this will kill the public subsidiary, but even if the government props it up, there is no reasonable reason for a recovery on the equity. The same is true of AIG . . . if they survive it will be because the government propped them up for long enough to do so . . . and the rewards should go back to the goverment (taxpayers), not some random shareholders in a bankrupt company.

 

I didn't start commenting on these companies to pick a fight. If there is an opportunity here, I would like to get over my bias and understand it. I just don't see it.  Any return to shareholders in these companies seems to me like a gift from the US taxpayer, and I don't understand who in government is motivated to make that gift. I am interested because I repect Berkowitz . . . these compnies are so hated (by myself among others) that if he is right, it will be one hell of an investment. I really have a tough time trying to guess what he could be right about though . . .

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txlaw,

 

I think the fact that Whitman, Berkowitz and Buffett are on different sides of this argument suggests to me that these stocks go in the too hard pile - at least for me.  I think they are really a political question. Whitman recapitalized MBIA and the government allowed the bond insurer to steal the money from the parent for political reasons. This is what the fraudelent conveyance lawsuit is about.  AIG went bankrupt and the government kept them alive, which is the only reason they have a market cap right now.

 

I readily admit, I am a US taxpayer, and maybe I am too upset about these situations to see the investment merits clearly. But if the rule of law still applies, I don't think these are good investments. Whitman should win his lawsuit in any reasonable courtroom . . . this will kill the public subsidiary, but even if the government props it up, there is no reasonable reason for a recovery on the equity. The same is true of AIG . . . if they survive it will be because the government propped them up for long enough to do so . . . and the rewards should go back to the goverment (taxpayers), not some random shareholders in a bankrupt company.

 

I didn't start commenting on these companies to pick a fight. If there is an opportunity here, I would like to get over my bias and understand it. I just don't see it.  Any return to shareholders in these companies seems to me like a gift from the US taxpayer, and I don't understand who in government is motivated to make that gift. I am interested because I repect Berkowitz . . . these compnies are so hated (by myself among others) that if he is right, it will be one hell of an investment. I really have a tough time trying to guess what he could be right about though . . .

 

I can certainly understand why one would hate these companies due to one's political/philosophical viewpoint, but I do think that this disgust towards government action could cloud one's investment judgment.  I don't take your comments as trying to pick a fight.

 

My own take is that municipal bond insurance serves a very important function in our economy.  Therefore, it made complete sense that the insurance commissioners approved MBIA's transformation plan.  This was actually one situation where bondholders actually were hit instead of saved by government action, if you buy into Third Avenue's suit. 

 

I will reserve judgment on whether the suit has merit until I have read the complaint and other pleadings.  It's never easy to win in the courtroom, and my guess is that there will be a settlement at some point, in which case the public finance subsidiary will have its ratings upgraded and will begin to write new business.  If that happens, MBIA's adjusted book value could be legit in a few years. 

 

Even if MBIA goes into complete runoff, I'm not so sure the equity will be wiped out.  Unlike a bank, where almost all liabilities can come due immediately if there is a run on the bank, the monolines will be required to pay out money over time.  MBIA will also try to recover damages from bond issuers who committed fraud during the bubble years.  It's not at all clear what the runoff value of MBIA is, but Berkowitz apparently thinks it's at least in the single digits. 

 

Note that all four superinvestors mentioned have found it attractive to get into the municipal insurance business during the crisis.  Berkowitz and Ross are long monolines.  Whitman held both MBIA debt and common stock at one point, so he was actually long MBIA until he had to choose sides.  Presumably, Whitman thinks he can get a better return by being paid off as a creditor than by holding common at the prices he paid while the business goes into runoff or rebounds.  Whitman went in too early, and when the NY Insurance Commissioner approved the transformation plan -- for the good of the country, I believe -- his debt investment was materially impaired. 

 

Buffett also likes the municipal insurance business.  Ajit Jain offered to reinsure MBIA's entire municipal portfolio at one point.  I think Berkshire was hoping that almost all the monolines would be wiped out and that AGO and BHAC would be able to get duopoly premiums in the US market.  The offer to reinsure their entire portfolios was a predatory move -- it would have been amazing for BRK shareholders had it happened.  But the monolines refused and are trying to earn themselves out of trouble.  Buffett probably thinks that pricing won't be as attractive as a result until we start seeing lots of municipal defaults.  AGO, which dominates at this time, appears to be happy with the pricing environment given their market position.

 

When munis start defaulting, BHAC will probably start writing business in a hard market.

 

You are absolutely correct that AIG would have entered into bankruptcy without government intervention.  Furthermore, the common would have been worthless had they been forced to break up at fire sale prices.  As it is, the pre-bailout shareholders who bought at much higher prices essentially got wiped out (not the bondholders though).  I think the facts have changed now to where AIG will be allowed to divest and earn its way to health.  The government will get a return on its investment and AIG will remain a going concern.

 

That's a good thing as long as we have meaningful reform that assures this does not happen again.

 

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I am also confused as to Berkowitz's purchases.  As for AIG, if you look at their board it is composed of non-insurance types (which I question the wisdom decisions made by this group who is light on insurance experience - the only financial services guy (Golub resigned a while back)).  His argument for AIG and C is that the gov't has forced them to write-down thier book to below FV.  The last time I looked at C and the other investment banks/banks, if you pulled out the trading profits, there was no profitability. 

 

Accrording to Berkowitz interviews, he counts the cash and tries to kill the company.  In this case I miss where both of those steps are.

 

Packer 

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His argument for AIG and C is that the gov't has forced them to write-down their book to below FV.  The last time I looked at C and the other investment banks/banks, if you pulled out the trading profits, there was no profitability. 

 

I don't think that's his argument at all.  Berkowitz, like Buffett, cares about the future earnings power of financial institutions like AIG and C.  Tangible common equity and all those other book value measures are only helpful insofar as they tell you whether the bank is undercapitalized and is at risk of being seized by the regulators. 

 

The pig is going through the python, and what matters is what remains when everything is digested.

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His argument for AIG and C is that the gov't has forced them to write-down their book to below FV.  The last time I looked at C and the other investment banks/banks, if you pulled out the trading profits, there was no profitability.  

 

I don't think that's his argument at all.  Berkowitz, like Buffett, cares about the future earnings power of financial institutions like AIG and C.  Tangible common equity and all those other book value measures are only helpful insofar as they tell you whether the bank is undercapitalized and is at risk of being seized by the regulators.  

 

The pig is going through the python, and what matters is what remains when everything is digested.

 

Berkowitz believes we are "in the spring of a recovery".  Those are his words.

 

Given that thesis, C is a no-brainer.  However, if you think we're in for a very nasty economic surprise, then it is too early as they would need to boost reserves further.

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His argument for AIG and C is that the gov't has forced them to write-down their book to below FV.  The last time I looked at C and the other investment banks/banks, if you pulled out the trading profits, there was no profitability. 

 

I don't think that's his argument at all.  Berkowitz, like Buffett, cares about the future earnings power of financial institutions like AIG and C.  Tangible common equity and all those other book value measures are only helpful insofar as they tell you whether the bank is undercapitalized and is at risk of being seized by the regulators. 

 

The pig is going through the python, and what matters is what remains when everything is digested.

 

 

I almost barffed when I saw what Bruce bought, but there is kind of a workout logic at play.  All the big banks and many other financial institutions have been insolvent at one time or another, kept afloat by the government.  With this support, eventually they manage to "earn" their way out of the hole.

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Its actually a very good idea.

 

Its virtually certain that a large number of US munis are going to default over the next 6-18 months. When they do, all munis will find financing very expensive or impossible to get - unless MBIA can actually cover the defaults. To realistically do so they would have to sell their investments in quantity, & the net buyer would effectively have to be the Fed. The alternative is a collapse in the US bond market, not unlike the Greek Sovereign crises (California alone is roughly the same size as Greece) .

 

You're buying a future cash flow at a deeply distressed discount, & you have an implied fed backstop driving that discount even higher. If it gets nationalized you win as the CF discount drastically declines. Same thing if the implied backstop becomes explicit.

 

Long term, Munis don't default & this is a very profitable business. Along the way its highly likely there will be debt/equity conversion, & an existing bond/equity holder will end up with a substantial chunk of the company. If you're patient you win, if you trade you win, but you're not necessarily the same investor.

 

There's been growing talk of the need for a 2nd US fed intervention to keep the US economy going. Most would think that MBIA would be a highly likely recipient.

 

SD

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For the record, Bruce has been wrong and/or contradictory from time to time. He sold Berkshire, then bought it back. He held Pfizer as the largest holding while speaking about how Berkshire was "too big" to get the kind of returns he wanted (Pfizer was even bigger than Berkshire at the time). So everybody can make mistakes from time to time.

 

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For the record, Bruce has been wrong and/or contradictory from time to time. He sold Berkshire, then bought it back. He held Pfizer as the largest holding while speaking about how Berkshire was "too big" to get the kind of returns he wanted (Pfizer was even bigger than Berkshire at the time). So everybody can make mistakes from time to time.

 

 

True.  And so has WEB.

 

Platitudes and contradictory statements abound both from Bruce Berkowitz and WEB.  They are not as straightforward as Charlie Munger, and you always have to read between the lines when trying to figure out the reasoning behind their actions.  For example, when asked why he liked health insurance cos, Berkowitz would reply that all he knows is that he's getting older and he wants more care and to live quality life as he ages.  That doesn't say much, does it?  But there was clearly much more than that behind his decision to invest in those companies.

 

I say this as someone who really admires both men. 

 

Regarding Pfizer, I don't know why Berkowitz sold out.  It could be a case of selling that which is cheap to buy that which is even cheaper.  Perhaps he didn't like the Wyeth acquisition?  Perhaps he thinks that tax reform could change his valuations of the company?  It's hard to say. 

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For example, when asked why he liked health insurance cos, Berkowitz would reply that all he knows is that he's getting older and he wants more care and to live quality life as he ages.  That doesn't say much, does it?  But there was clearly much more than that behind his decision to invest in those companies. 

In fairness to him, when he's getting interviewed by half-wits from CNBC, they're more interested in the speculative topics, rather than silly boring things like profits and annual reports. It's much better to guess which company will have the next blockbuster drug, or which company is going to make us billions from cloud computing.
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His argument for AIG and C is that the gov't has forced them to write-down their book to below FV.  The last time I looked at C and the other investment banks/banks, if you pulled out the trading profits, there was no profitability.  

 

I don't think that's his argument at all.  Berkowitz, like Buffett, cares about the future earnings power of financial institutions like AIG and C.  Tangible common equity and all those other book value measures are only helpful insofar as they tell you whether the bank is undercapitalized and is at risk of being seized by the regulators.  

 

The pig is going through the python, and what matters is what remains when everything is digested.

 

Berkowitz believes we are "in the spring of a recovery".  Those are his words.

 

Given that thesis, C is a no-brainer.  However, if you think we're in for a very nasty economic surprise, then it is too early as they would need to boost reserves further.

 

Berkowitz believes we are "in the spring of a recovery", & prem watsa & his team at ffh apparently believe we are on the brink of deflation. 2 of the best with polar opposite views & investment convictions. its enough to make your head spin!

 

1 thing seems certain: we are on the cusp of something majorly momentus. personally, i hope bruce is right...there's alot of pain & fear out there. to think it could get much worse is just sad. i say that despite being a shareholder of ffh & having the utmost respect for prem. yea, but hope alone wont spare you a dime...

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"Regarding Pfizer, I don't know why Berkowitz sold out."

I remember seeing or reading something to the effect that he did not like the recurrent one time expenses that PFE kept reporting.

 

Yeah, I remember reading that too. 

 

I don't buy that explanation.  That would be an excuse not to buy in the first place if that was really what was motivating Berkowitz to sell out. 

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His argument for AIG and C is that the gov't has forced them to write-down their book to below FV.  The last time I looked at C and the other investment banks/banks, if you pulled out the trading profits, there was no profitability.  

 

I don't think that's his argument at all.  Berkowitz, like Buffett, cares about the future earnings power of financial institutions like AIG and C.  Tangible common equity and all those other book value measures are only helpful insofar as they tell you whether the bank is undercapitalized and is at risk of being seized by the regulators.  

 

The pig is going through the python, and what matters is what remains when everything is digested.

 

Berkowitz believes we are "in the spring of a recovery".  Those are his words.

 

Given that thesis, C is a no-brainer.  However, if you think we're in for a very nasty economic surprise, then it is too early as they would need to boost reserves further.

 

He does seem to believe we are "in the spring of a recovery."  I hope so too.

 

But the beauty of the Citi investment is that it is sheltered against a nasty economic surprise because of its capital position and its actions to shrink Citi Holdings. 

 

So I don't think Berkowitz is too early.  If things go really badly, shareholders won't lose any money.  Downside protection is the mantra at Fairholme.  If things go adequately or really well, then we got a nice annualized return coming our way in a couple of years.

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Its actually a very good idea.

 

Its virtually certain that a large number of US munis are going to default over the next 6-18 months. When they do, all munis will find financing very expensive or impossible to get - unless MBIA can actually cover the defaults. To realistically do so they would have to sell their investments in quantity, & the net buyer would effectively have to be the Fed. The alternative is a collapse in the US bond market, not unlike the Greek Sovereign crises (California alone is roughly the same size as Greece) .

 

You're buying a future cash flow at a deeply distressed discount, & you have an implied fed backstop driving that discount even higher. If it gets nationalized you win as the CF discount drastically declines. Same thing if the implied backstop becomes explicit.

 

Long term, Munis don't default & this is a very profitable business. Along the way its highly likely there will be debt/equity conversion, & an existing bond/equity holder will end up with a substantial chunk of the company. If you're patient you win, if you trade you win, but you're not necessarily the same investor.

 

There's been growing talk of the need for a 2nd US fed intervention to keep the US economy going. Most would think that MBIA would be a highly likely recipient.

 

SD

 

QE 2 could very well be coming soon.  It sure seems like that's gonna happen.  Bill Gross just arguing for QE2 just a couple of days ago.

 

Munis will default, structured finance bonds will continue to default, and MBIA will have to sell assets they hold to make good on their promises (paying out on defaults over time).  From MBIA's perspective, they'd love to sell the assets they own at prices where yields are super low. 

 

Once the lawsuit is taken care of and they are able to write new business from their "good bank" subsidiary, they will have a hard market for municipal bond insurance and they will deploy whatever capital is left from the "bad bank" into their "good bank" subsidiary. 

 

For MBIA, there are lots of similarities to what's happening with Citi.

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