Warren Buffett has gotten out of the municipal credit-default swaps he bought before the financial crisis of 2008. Many investors think this is a signal that Buffet no longer has confidence in municipalities’ ability to cover their debt obligations.
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The increase in municipal bankruptcies may be a testament to the uncertainties in the market. Buffett’s pullout comes just as investors are pouring money into the muni markets.
Muni bonds are returning more than Treasury bonds and are perceived to be safe. Limited new issues are adding to the demand for municipals, especially in light of possible tax increases when the current tax laws expire at the end of the year.
The risk of municipal defaults is rising, as evidenced by the increased number of municipal bankruptcies in California. In 2007, Lehman Brothers purchased insurance from Buffett’s Berkshire Hathaway against default on bonds from 14 states that included California as well as Texas, Florida, and Illinois.
Berkshire provided a 10-year time horizon for the insurance so Buffett’s pullout signifies a lack of confidence a full five years short of that original term. Berkshire still owns about $8 billion in municipal debt that can’t be terminated before the underlying bonds mature between 2019 and 2054.
The firm also received payment upfront for providing the insurance. Other institutions also bought insurance from Berkshire. Some investors see distressed municipal bonds
as a good investment at the right price. Others have been raising cash in anticipation of interest rate increases or widening credit spreads.