Investor Warren Buffet arrives for the premiere of the film "Wall Street: Money Never Sleeps" in New York, Sept. 20, 2010.Lucas Jackson/Reuters
Municipal bond investors shouldn't get too spooked by Warren Buffett. The Oracle of Omaha's decision to unwind $8.25-billion (U.S.) of derivatives deals is being interpreted as a bearish sign on U.S. states and cities. Investors, however, are better off keeping their own counsel on a $3-trillion market so broad and diverse. It's a lesson learned from muni doomsayer Meredith Whitney.
Berkshire Hathaway, Mr. Buffett's insurance and investing conglomerate, didn't say why it closed out about half its credit default swaps – insurance-like contracts – associated with municipal debt. It could be something as simple as the fact that equivalent insurance has become much more expensive since the first contracts were written in 2007. States and cities, after all, have struggled to balance budgets in the years after the housing bust.
This wasn't exactly a news flash from Mr. Buffett, though. Bankruptcy filings from three California cities this summer punctuated the point quite effectively. Even so, yields on triple-A-rated municipal debt have hardly budged from where they started the year at 1.83 per cent. Buyers, meanwhile, haven't been shy about financing the Golden State.
A big reason why munis have proven so resilient is retail investors. They make up about two-thirds of the market, and have come to realize the bonds are not the monolith they once thought. Bond insurance, which pre-crisis would confer triple-A ratings on a whole host of issuers whether they be school districts or cities, had lulled investors into thinking they didn't have to worry much about credit risk. When Ms. Whitney, an independent banks analyst, said in December, 2010, that U.S. municipalities would default on hundreds of billions of debt, she triggered a rush for the exits.
Sellers haven't been proven right. In fact, yields have fallen substantially, with lower-rung investment-grade debt now paying 3.70 per cent, down from 5 per cent around the time of Ms. Whitney's pronouncement, according to Thomson Reuters Municipal Market Monitor. The number of defaults remains minuscule.
Investing in municipal debt is tougher, for sure. The disappearance of bond insurance means buyers must do more of their own due diligence on issuers, some of which can be risky. But it doesn't take an oracle to see that either.