(August 21st, 2012) The municipal bond market is abuzz today after the Wall Street Journal reported that Warren Buffett’s Berkshire Hathaway has recently terminated credit-default swaps insuring $8.25 billion of municipal debt. The contracts are basically insurance against municipal bond defaults, which would require Berkshire to pay out in the event of a default. (Learn more about credit default swaps) The story ran under the headline “Buffett’s Move Raises a Red Flag” and was quickly followed up by stories with headlines such as “Trouble Looming for Municipal Bonds?” by large news organizations like the LA Times.
Similar to the mainstream media’s reporting on the NY Fed default study, publications are jumping the gun on these stories, without researching all the facts.
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This is not a new story.
This exact story is around 3 weeks old when both Bloomberg and one of the same reporters who released yesterday’s story wrote about it for the Wall St. Journal. The bigger picture story of Buffett’s dislike of insuring municipal bonds? That one goes back many years.
One of the many casualties of the financial crisis were municipal bond insurers. In addition to insuring municipal bonds, many firms also got into the business of insuring the same pools of subprime mortgages that were at the center of the financial crisis. As a result of losses related to those products almost all the major bond insurers lost the high credit ratings which allowed them to be in the bond insurance business. As Buffett’s firm came out of the crisis relatively unscathed, he decided to try and fill that void with a new firm formed to offer bond insurance, called Berkshire Hathaway Assurance Co..
As the financial crisis deepened however, Buffett’s view of municipal bond insurance changed. He decided that as more cities and states faced fiscal problems, they would be more likely to file for bankruptcy instead of putting their citizens through the hardships required to continue making their debt payments. For this reason Buffett pulled out of the municipal bond insurance business back in 2009.
The Bottom Line
As you can see in the Journal’s story, the municipal bond CDS contracts that Buffett is now closing are from 2007, when he was just getting started in the muni bond insurance business. Since he soured on that business in 2009, it is not likely that he was actually optimistic on muni’s until this month, and wanted to be left with this position until now. A more plausible explanation is that Buffett has been wanting out of this position since at least 09, and has simply not been able to get out of it at a good price until now.
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