Update on ‘Florida goes to Vegas’…

Last August I pointed out that the brave leaders of the State of Florida had in effect taken a huge punt on the weather. (Using the tried and tested gambit of bribing their citizens with their own money. Only better – leveraged!)

Well it seems that these same good folks have lost a bit of their nerve as 2008 hurricane season starts and the metaphorical roulette wheel starts to slow (from the Guardian):

Warren Buffett’s Berkshire Hathaway fund has taken a $224m (£113m) bet that Florida will not be hit by devastating hurricanes in the coming months. That is the amount the US state has agreed to pay Berkshire upfront in return for the fund coming to its rescue if hurricane damages cost more than $25bn this season, which runs from June 1 to November 1.

If damages exceed $25bn, Berkshire will buy $4bn in 30-year bonds issued by the state. The money will ensure Florida does not run into cash flow problems in the clean-up. Florida will have to buy the bonds back; the interest rate is 6.5%. State officials have agreed to the deal, even though they admit there is only about a 3% chance of damages going so high, because they believe the credit crunch could limit their access to funds if this is a particularly bad hurricane season.

So let me get this straight. Basically Florida lined up a loanshark, just in case they couldn’t pay their bookie if their bet didn’t come in. It looks like a pretty clever deal for Vinnie Mr. Buffett: if the terms have been correctly reported, effectively he is being paid $224mn for a ‘knock-in’ credit spread + interest rate lock. On $4bn of bonds, if the knock-in is exercised, the premium should protect Buffett up to c. 7% before he starts incurring mark-to-market losses on the overall trade. I’m no expert and it’s late so I’m not even going to try to hack a model together, but it seems like this is a pretty good deal for the man from Omaha. (And btw, a derivative by any stretch of the imagination…)

It’s also probably a relatively prudent thing for Florida to do, even though they obviously shouldn’t be in such a dire position to start with…and does beg the question, is this the best deal they could do? I can’t get the image out of my head of some hapless middle aged gambler, knuckles white as his nails dig deep into the felt, all the blood drained from his face, beads of sweat gathering on his pencil moustache, as the terror washes over him with the realization that the dice moving in slow motion down the table…might just come up snake eyes…

You couldn’t make this stuff up.

I guess there is no point mentioning the bats…

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