Apparently, not Warren Buffett anymore….. Buffett has pulled back from accepting insurance premiums to guarantee the debts of state and local governments. Berkshire Hathaway had originally stepped into the market in 2008 when MBIA and other insurers began to fail. Buffett also sold credit default swaps (CDS), which is basically another form of default insurance, and this is what he seems to have jettisoned.
This blog post from the Federal Reserve Bank of New York tells the story of municipal bond defaults, which are higher than most people realize in the $3.7 trillion market. Basically, there are two parts to the municipal bond market – a part contining bonds rated by Moody’s and S&P and another part consisting of unrated bonds. Unrated bonds typically suffer a significantly higher default rate because shakier issuers are unlikely to pay for a rating that winds up being below investment grade. So there’s a self-selection aspect to the municipal bond market, with those issuers selecting to be rated generally being higher quality.
About half the market is bonds held by individual investors, and around one quarter of the market is in municipal bond mutual funds. (It’s a wonder to me that most individuals buy these bonds without the benefit of pricing and diversity that you’d get in a fund. The municipal market has to be among the most illiquid, where entering even with a few million dollars makes you look like a piker — and makes you pay accordingly.)
Regardless of how wealty individuals choose (or are forced by their brokers and handlers) to own these bonds, given what happened with subprime mortgages, it’s a wonder the ratings agencies haven’t been duped with municipals (so far). Perhaps one can also assume municipal bonds are less difficult to rate than complex mortgage securities.
In any case, issuers — even higher quality ones – aren’t paying for insurance anymore. Additionally, with governments increasingly strapped for cash, cutting the expense for insurance makes economic sense.
As an investor, though, should the fact that issuers are foregoing insurance costs encourage or discourage you from lending to state and local governments? Perhaps most highly rated bonds will be fine and don’t need insurance, but shouldn’t investors demand a greater yield for seemingly less security?
In any case, the following graph shows a five-year closing price of the iShares S&P National AMT Free Muni Bond ETF (MUB). Price are about as high (and yields as low) as they’ve been in the entire period.
