Seems there are some people trying to discern the meaning behind Berkshire Hathaway’s decision to terminate credit-default swaps insuring $8.25 billion of municipal debt.
Is Warren Buffett turning bearish on municipal finances?
The oracle himself isn’t commenting, which leaves plenty of room for the punditry to weigh in.
A bet on derivatives
These credit-default swaps are bets on municipal debt. If a bond defaults, the credit-default holder is on the hook. It is notable, that according to The Wall Street Journal, there were no defaults among the swaps Berkshire insured.
Berkshire’s contracts were originally purchased by Lehman Brothers Holdings Inc. in 2007, before the firm filed for bankruptcy, the Journal reported. Even with Berkshire’s move to end these contracts, the conglomerate still retains swaps tied to about $8 billion in debt issued by hundreds of cities, states and municipalities, which won’t be terminated before the maturity of the underlying bonds.
Any attempt to read the tea leaves behind Berkshire’s move is unproductive – and unwise. Statistically, there have been no significant developments in the municipal bond market that would presage the logic of such a move, and investor demand for munis remains strong.
A likely motivation, as some analysts have pointed out, probably has more to do with the market for these derivative contracts and not the credit worthiness of the bonds themselves. Since 2007, when the contracts were written, insurance has become more expensive, which makes sense as states and cities work through their fiscal challenges. This may have enabled Berkshire to take a profit on the older contracts.
Not quite the clarion call to exit the market, as some have suggested, but a simple explanation for a large company that makes innumerable trading decisions every day.
The bigger, more revealing picture
Despite a few high-profile instances, muni defaults of rated muni bonds remain extremely rare. As we have pointed out “Seeing Beyond the Headlines”, investor enthusiasm for munis is exceptionally strong, even for bonds issued by the headline-rich state of California. In fact, according to Thomson Reuters Municipal Market Monitor, interest rates for lower-quality, investment-grade debt is now at 3.70%, down from 5.00% almost three years ago, when apocalyptic ranting about municipal finances peaked. Hardly a call to flee.
Although it produces headline grist for the financial media mill, it is futile to guess why Berkshire Hathaway liquidated one of its many wagers. For the individual investor, it’s also unhelpful. Taking an opaque trading cue from a multibillion-dollar behemoth is risky.
We prefer a more productive endeavor: Keep the big picture in mind. Select your bonds carefully and maximize your value, for which an oracle isn’t necessary.