Buffett Action Signals Concern Over Municipal Bonds

Published August 23, 2012

When the Oracle of Omaha speaks, investors tend to listen.

And with actions speaking louder than words, there may be good reason for municipal bond investors to pay special attention.

Multibillionaire investor Warren Buffett’s Berkshire Hathaway Inc. has decided to end credit default swaps that had insured approximately $8.25 billion of municipal debt around the country.

The early termination became public in mid-August in a quarterly report Berkshire Hathaway filed with government regulators. The credit default contracts were ended five years early.

Some investors and industry analysts say the Berkshire Hathaway decision indicates Buffett has serious worries about municipal finances.

‘He’s Expecting Trouble’

“As any Buffett follower knows, he is a long-term investor and rides out short-term bumps. If he is bailing with a few hundred million in losses, he is expecting trouble in the muni market,” said economist Robert Wenzel, editor and publisher of EconomicPolicyJournal.com. “As I have said before, there is absolutely no reason to own municipal bonds at this time.”

The move by Berkshire Hathaway to pull out of the municipal bonds credit default market comes on the heels of high-profile municipal bankruptcies in Stockton and San Bernardino, California. The restructurings could reduce the amount of money the municipalities repay to creditors.

In June in San Diego and San Jose, California, residents voted overwhelmingly to roll back retirement benefits for local government workers. The referenda for the rollbacks were sparked by concerns that soaring retiree pension and health insurance costs could bankrupt those communities.

Ratings Agencies’ Concerns

Moody’s Investors Service recently reported “the risk of default on municipal bonds in California is rising.” Fitch Ratings also reported “continued stress for many local governments.”

Nonetheless, investors seeking safety and higher returns than they can obtain buying Treasury debt have been pouring money into municipal bonds. This is happening despite the recent bankruptcy filings of the California cities and last year’s bankruptcy filings by the Pennsylvania capital of Harrisburg and Jefferson County, Alabama, which includes Birmingham. The latter county has more than $4 billion in debt, the result of a huge sewer project and corrupt financial dealings in which at least 17 persons have been sent to prison.

Advice: ‘Get Out of Munis’

Outright financial crimes are only a small part of the problems many municipalities face, however, said Patrick Barron, who teaches economics at the University of Wisconsin and University of Iowa and runs his own banking industry consulting business. The main cause is politics as usual.

“For decades many municipalities have been promising government employees retirement benefits for which they have set aside almost nothing, relying instead on a steadily increasing flow of tax revenues. Well, the tax revenues are not increasing, and in many cases they are decreasing. The municipalities just cannot pay them,” Barron said.

“I deduce that Warren Buffet sees the writing on the wall. My advice is to get out of munis,” he said.