Muni Defaults: Buffett's Warning Is Loud and Clear

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Message received loud and clear, Warren. In a move that should give genuine concern to investors in U.S. municipal bonds, Warren Buffett's Berkshire Hathaway (NYS: BRK.A) (NYS: BRK.B) has terminated insurance contracts it sold against default on $8.25 billion in state and municipal debt -- half the total exposure it was carrying at the end of June. But that's not half of the story.

Did Buffett eat a loss?
Indeed, given a free hand, Berkshire might have eliminated its exposure altogether; alas, according to its most recent quarterly report, the remaining contracts do not permit termination prior to the maturity of the underlying obligations, which ranges from 2012 to 2054. Worse still, it appears that Berkshire may have been willing to eat a loss on the contracts in order to close them out. According to TheWall Street Journal, Berkshire originally sold the insurance on $8.25 billion in bonds from 14 states, including Texas, Florida, California, and Illinois, in 2007. As the Journal story explains: "[The] cost of insuring the states from default, however, is now much higher than in 2007, according to data provider Markit."

Whether or not they ultimately come to the same conclusion as Buffett, investors who own a muni mutual fund or ETF such as the iShares S&P National AMT-Free Municipal Bond Fund (NYS: MUB) or the SPDR Barclays Capital Municipal Bond ETF (NYS: TFI) are well advised to reassess their exposure.


Explain this to me like I'm a four-year-old
As far as I'm concerned, the economics of investing muni bonds don't add up. U.S. Treasuries offer a pitiable return; take the two-year Treasury note, which offers investors all of 29 basis points in annual yield (100 basis points equal one percentage point). That's not an investment, it's a hunger strike, and I can't refrain from questioning the sanity of investors making that choice. With that in mind, what then are we to make of municipal bond investors who are willing to swap the default risk of the U.S. federal government for that of states and municipalities to pick up 14 basis points in taxable equivalent yield? If you're resigned to starving yourself, I don't see the point in fiddling with a set rat trap to obtain a single grain of corn.

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The article Muni Defaults: Buffett's Warning Is Loud and Clear originally appeared on Fool.com.

Fool contributorAlex Dumortierholds no position in any company mentioned.Click hereto see his holdings and a short bio; you can follow him@longrunreturns. The Motley Fool owns shares of Berkshire Hathaway.Motley Fool newsletter serviceshave recommended buying shares of Berkshire Hathaway. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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