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Lindley Estes is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.
Buffett role similar to one Morgan once played?
The U.S. stock market had been cut in half by over-expansion and speculation, the economy was in recession, credit was tight, and the Treasury Department was pumping money into the financial system to avert disaster.
The year was 1907.
In most historical accounts of the Panic of 1907, financier J.P. Morgan is given credit for staving off disaster by gathering leading bankers and financial experts at his home.
The group provided capital that kept banks afloat, obtained lines of credit and purchased the stock of healthy companies. The panic passed within a few weeks, and Morgan was hailed as a savior. The panic led to the formation of the Federal Reserve.
Fast-forward a century, and the bank that still bears Morgan’s name is one of the largest in the world. Last year, J.P. Morgan Chase & Co. was part of a group of large banks that attempted to organize a "superfund" to buy distressed assets, thereby stabilizing the financial system. The plan ultimately failed.
This past week, another potential solution emerged. Just as it did a century ago, it came from a man in his 70s whose long history of business success made him one of the country’s wealthiest men.
Warren Buffett appeared on CNBC on Tuesday to describe an offer his company, Berkshire Hathaway, had made to the nation’s three largest municipal bond insurers: MBIA Inc., Ambac Financial Group Inc. and Financial Guaranty Insurance Co. The stock market jumped Tuesday after Buffett’s interview.
To greatly simplify the matter, a subsidiary of Berkshire Hathaway agreed to provide reinsurance to the three companies’ $800 billion municipal bond portfolio for a hefty premium.
Municipalities sell bonds to pay for projects such as sewer systems and schools. Backed by the Triple-A ratings of the bond insurers, the municipalities are able to pay lower interest rates to investors.
In recent years, bond insurers strayed from the safe world of municipal bonds to the murkier waters of complex asset-backed securities. Losses on these products have threatened the insurers’ Triple-A ratings. Should they lose them, municipalities could have to pay higher interest rates on their bonds, which in turn could drive up taxes.
Berkshire Hathaway, whose cash horde recently surpassed $40 billion, is at no such risk of losing its Triple-A credit rating. Buffett said on CNBC that his company’s offer, if accepted, would restore stability to the municipal bond market.
Ambac and another of the bond insurers have rejected Buffett’s offer. Municipal bonds rarely default, so the three insurers would be giving away the safest parts of their shaky portfolios.
So is Buffett, 77, a latter-day white knight riding in amid the financial wreckage, as Morgan did 100 years ago?
There are similarities between the men in terms of financial resources, age, experience, business reputation and the potential for profit, said Robert F. Bruner, dean of the University of Virginia’s Darden School of Business and co-author of "The Panic of 1907."
But Bruner also noted some differences between the two situations.
He said Morgan’s efforts were more collective, as occurred last year with the banks’ proposed superfund, while Buffett seems to be acting more on his own to benefit the shareholders of Berkshire Hathaway. Bruner added that it’s possible that Buffett is pulling people together behind the scenes.
It remains to be seen how the current situation works out, and whether Buffett will play as dramatic a role as Morgan did 100 years ago. Bruner pointed out that Berkshire’s pile of cash, while enormous, is nowhere near enough to bail out the entire financial system.
If nothing else, the comparison is interesting. And investors can perhaps take comfort that the country has been here before, and weathered the storm.