A lot of people have become very worried now that Berkshire Hathaway made the move to close out $8 million worth of the municipal credit default swaps that they had. Plus, there are a lot of market commentators and journalists who have been wondering if Mr. Buffett is now sour on municipal bonds altogether. Does he still liked them as an investment vehicle? Should other investors stay away from them as well?
Charles Gasparino brings us the latest bit of speculation on this matter. He believes that the move Warren Buffett made with the municipal credit default swaps had everything to do with political reasons. He believes that Warren Buffett is in a disagreement with President Obama over politics in regards to our country’s welfare system. The truth is that Gasparino’s article in the New York Post is possibly the most convoluted thing ever written about municipal bonds.
Gasparino said “and even if, when you dig deeper, the move suggests Buffett wasn’t making a bet against all munis but only those that adopt some of the same policies he and President Obama are advocating on a national level.”
Gasparino also said that he has been making calls to participants in the market, and he was capable of determining that some of the municipal credit default swaps that Warren Buffett recently closed out were written on the debt of Illinois and California, which are two states that happen to be in really bad shape fiscally.
There is no denying that the states of California and Illinois are cash-strapped right now, and they have some very difficult financial decisions that they must make. The bigger issue is that both states are constitutionally required to prioritize their bondholders. That would make the constitutional provisions which render credit default swaps against the states useless, but only if the entire economy collapses. There is no question that these bonds are definitely going to be paid. It is not possible for a state to declare bankruptcy under federal law.
So the municipal credit default swaps are not actually insurance against states defaulting, but they are a speculative security that can allow an investor to book losses and gains. Buffett publicly announced that derivatives such as credit default swaps are “weapons of mass destruction,” but it didn’t stop Berkshire Hathaway from investing in these securities, even though they get burned by them on occasion.
The best way to truly get a good idea of Warren Buffett’s views on municipal bonds is to take a look at the investment portfolio of Berkshire Hathaway. The truth is that it doesn’t really look like much has recently changed. If you want to look at it for yourself, you will need to go to the “investments in fixed maturity securities” section of their 10Q SEC filing.
By the end of 2011, Berkshire Hathaway had over $3 billion worth of municipal bonds, but if you look at their most recent filing on the date of June 30, 2012, it only dipped a little bit and it’s now $2.9 billion which is only a 4% decline. Since municipal bond yields haven’t done so well, it is very surprising that the decline is not much worse. Berkshire Hathaway really doesn’t get any major benefit from the tax exemption that municipal bonds offer, so it actually isn’t an asset class that will provide Berkshire Hathaway with a great deal of investment income.
If Warren Buffett was completely sour on municipal bonds, he would most likely get rid of all of his cash bond holdings and move that money into U.S. Treasury bonds. Remember, Warren Buffett is a very smart investor, so you have to look at all of the decisions that he makes from a lot of different angles, and don’t just pay close attention to the political narrative.