How Safe Are Your Muni Bonds? Not Very, Warns Warren Buffett

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Warren Buffett
Does the prospect of earning 0.1% on a bank savings account leave you ... unenthused? Do the 0.2% interest rates that the U.S. government is paying on two-year Treasuries stick in your craw? Maybe you're thinking it's smarter to buy a nice, safe 10-year municipal bond, paying 1.8%, and tax-free to boot?

Think again.

A couple of years ago, when testifying in Washington, D.C., about the state of the U.S. economy, billionaire super-investor Warren Buffett warned Congress of a looming "terrible problem" with U.S. municipal bonds.

Now, Buffett is back, and warning that the crisis is closer than ever.

A Little Bit of History

Time was, municipal bonds ranked among the safest investments you could make. Cities, counties and states that wanted to raise money for a public works project would sell bonds to local companies and taxpayers. When the bonds came due, they'd pay off like clockwork -- because no elected official wants to risk defaulting on his own constituents.

Beginning around the 1970s, though, things began to change. Recognizing that muni bonds were a safe investment that almost never defaulted, insurance companies began clamoring for the right to insure the things, charging small premiums and depositing them right in the bank, rarely worried that they might have to pay out.

Busted, Hamstrung ... and Insured

Today, with states and municipalities swimming in debt, the politics of bankruptcy have changed.

No longer do states and municipalities have to worry so much about defaulting on voters when declaring bankruptcy. Today, they know that in the event of a default, far-away companies with names like Assured Guaranty (AGO) and Ambac Financial -- and yes, Berkshire Hathaway (BRK.A) (BRK.B) -- are contractually obligated to step in and foot the bill in the event of default.

A 2010 report noted that some $2.8 trillion worth of muni bonds were insured against default by private companies.

Chances are, this knowledge is contributing to the recent rash of municipal bankruptcies in California, for example. Over the past month, first Stockton, then Mammoth Lakes, and finally San Bernardino have all filed for bankruptcy protection.


Whatever the motivation for these cities violating the bankruptcy taboo, Buffett believes that they've started the ball rolling in what could soon become a national trend.

The trend may not get as bad as Meredith Whitney's famous 2010 prediction of "hundreds of billions" of dollars in defaults, granted. But the way Buffett sees it, every time you hear about "very sizable cities like Stockton or San Bernardino" declaring themselves insolvent, the "stigma" of other cities admitting they screwed up and can't pay their bills gets a little bit smaller. "The very fact they [file] makes it more likely" that other cities will follow suit, Buffett says.

What's It Mean to You?

Now here's where we get to the good news/bad news portion of the column.

The good news is that if muni bond insurers prove up to the task of paying what they owe on these bankrupt cities' bonds, people like you and me who bought the bonds should be able to rest easy.

The bad news, obviously, is that insurers' ability to pay isn't exactly certain. Insurer MBIA (MBI), for example, has only $3.6 billion in the bank, which won't make much of a dent if $2.8 trillion worth of muni bonds start to go bad. Also, MBIA has $13 billion in debt of its own. Assured Guaranty is in a little bit better shape, but Ambac has already filed for bankruptcy itself.

What does all of this mean for investors who've put their faith in "safe, tax-free" muni bonds? One thing's for certain: It's not good. If more munis start defaulting, and their "muni bond insurance" policies turn out to be worth less than the paper they're printed on, it's taxpayers who will be left holding the bag. A bag that when peered into, will be found depressingly empty of money.

Motley Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of Berkshire Hathaway and Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway.

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cpo1514

reporters (folks not in Obamas camp) need to ask Buffet why he wont pay his taxes, why he is using the roads Obama built and wont pay for them......after all, buffet does owe everything to the current Occupant.....

July 24 2012 at 8:26 AM Report abuse +2 rate up rate down Reply
larry

This guy owns half the world. Obama needs to get him to not only pay "HIS FAIR SHARE" but tax him to the MAX. If Obama really thinks the businessman didn't become a business owner without government help, including making Warren Buffett filthy rich, then---------------------------- it's payback time for Warren Buffett ! ! !

July 22 2012 at 9:55 PM Report abuse +2 rate up rate down Reply
mike edwards

this guy is greedy he just raised the price of the buffalo news on sunday to 275 like the old man needs the money we should take up a collection for the silver fox

July 22 2012 at 7:23 PM Report abuse rate up rate down Reply
jmg62

Please - no need to worry! Do like Philadelphia does and just keep finding "New Streams of Revenue"! Raise taxes twice in as many years to a total of 10% and because the citizens will BURN CITY HALL - putting off that last increase of 3.4% until NEXT year when the populace has a chance to "settle down". Ah, Mayor Nutter, City Council - no one is settling down - and we'll march on City Hall if that tax is passed. Not to mention the Water/sewage increase of 6.5% EACH year over 4 years! Oh, and don't forget about those Vouchers you want to push through for Charter and Catholic Schools because the Muslims and Jews want them to! No. No more. $94,000,000.00 in debt from the School District? There's $405,000,000.00 in UNCOLLECTED TAXES FROM PEOPLE THAT EVEN WORK FOR THE CITY! Ever hear of "GARNISHMENT"? Getta clue!

So LONG before you come after us again - picture it - City Hall - a building standing since Benjamin Franklin - surrounded in flames from your constituents who'd rather toss Molotov Cocktails than support secondary school systems TIMES 3 when no one seems to think FIXING the present one is worth doing. I'm out of money. So is the rest of Philadelphia. BTW: Paying for BREAKFASTS, LUNCHES and SNACKS for children who throw their tied together sneakers over fluorescent light fixtures putting shards of glass all over those below as their parent's sue the School District for cuts - or parent's suing because their child "graduated" not knowing how to read or do math (he skipped FIFTY FOUR - 54 DAYS! - that is - DAYS OF SCHOOL!) shouldn't be MY RESPONSIBILITY. On my one day off I guess I need run about with a shotgun getting your little miscreant off to school!? PARENT'S WERE HELD RESPONSIBLE IN THE PAST AS THEY SHOULD BE NOW. Indeed, I knew how to pour milk on a bowl of cereal when I was 5.

So Buffett can warn all he wants - I'd say he and muni holders should be able to take over cities and shake them up a bit. From Wall Street to the Ben Franklin Parkway - it's all come home to roost! Instead of sending out your goons to write tickets for having our trash out at 6:59PM when 7PM is the rule - or searching our trash for recyclables to look for a fine of $50 for first "offense" - why not take time to see about all those folks who've been living free and easy off OUR PAID TAXES! I'd like to look at the City Charter and SEE EXACTLY what my taxes are supposed to be paying for in terms of services - since more and more keep getting added on when I THOUGHT my TAXES ALREADY PAID FOR IT! Fricken criminals! If there's no corruption going on then spending has gotten WAY OUT OF CONTROL! Elected to do this for me - your days are numbered and a recall isn't out of the question!

July 22 2012 at 7:07 PM Report abuse +2 rate up rate down Reply
1 reply to jmg62's comment
metusmetu

It's about time someone else started thinking, it's to bad "all" people don't think like you do instead of just sitting back and taking everything these city's, states, and Feds hand out!! KEEP ON RAISING YOUR TAXES ETC., WE ARE OUT OF MONEY! YOU GOING TO LOCK US "ALL" UP???! As jmg62 says, "YOUR DAYS ARE NUMBERED"!! An you can take that any way you want to!!

July 22 2012 at 7:56 PM Report abuse rate up rate down Reply
apw79912

Meredith Whitney said that municipalities would go bankrupt. She predicted this years ago. Why is this news now?

July 22 2012 at 7:00 PM Report abuse rate up rate down Reply
Pinot Man

HEY WARREN, YOU DIDNT BUILD THAT BUSINESS SOME ONE ELSE DID! JUST ASK YOUR BROTHER OBUMA

July 22 2012 at 6:15 PM Report abuse rate up rate down Reply
rebecca jean

hey warren...shut up

July 22 2012 at 6:07 PM Report abuse +1 rate up rate down Reply
alfredschrader

Buffett's firm doesn't pay a dividend and Buffett only makes $100,000 a year salary. It's why the shares have gone so high, he never spends it. So, if you work there, don't expect to make any more than a mop salesman.

July 22 2012 at 5:46 PM Report abuse rate up rate down Reply
mgh406

What gave him the first clue? LOL

July 22 2012 at 5:19 PM Report abuse +1 rate up rate down Reply
kesac

Bonds at historicaly low interest rates are absolutely not safe. If you have a 3% bond, and rates go to 4 or 5%, who would want to buy your bond at face value. You will have to discount it to sell, so the purchaser gets that same 4 or 5% yield, and you are guaranteed to lose.
That is finance 101.

July 22 2012 at 4:50 PM Report abuse rate up rate down Reply
1 reply to kesac's comment
cpo1514

Kesac... want a job in the Federal Reserve??/ the current Occupant really needs folks that can add & count ......

July 24 2012 at 8:28 AM Report abuse +1 rate up rate down Reply