Contributed by Chriss Street:
According to a Securities & Exchange Commission regulatory filing, Berkshire Hathaway Inc. managed by world famous investor Warren Buffett, dumped half of their $16.5 billion investment in the municipal bond market. The Wall Street Journal described the secretive sale of a huge amount of “munis” by such a dominant investor as a “red flag” for the entire market in the tax-free bonds for state and local government. The quick sale and willingness of Buffett’s organization to take a substantial loss just before negative news was disclosed is highly suspicious from an “insider trading” standpoint. Given that Berkshire Hathaway owns Moody’s Investor Services, the most powerful credit rating agency, Berkshire Hathaway may have escaped a potential market collapse by selling on “material non-public information” from Moody’s.
In the last week, we published a series of devastating reports about the crumbling financial stability of California and the safety of the municipal bond market. Wednesday we broke “California Sales Tax Revenue Nose Dives by 33.5%”, on Friday we broke “Moody’s Warns of Mass California Municipal Bankruptcies” and Sunday we broke “Federal Reserve Warns Municipal Bonds Very Risky”. Each of these stories highlighted previously unknown risks in the muni market.
We scour financial regulatory filings and media stories to get early indications regarding the buying and selling of securities by major institutional investors. On June 13, 2010, the Wall Street Journal did run a story titled: “Investors Looking Past Red Flags in Muni Market”. The Journal highlighted that most investors were ignoring warning signs of deteriorating fundamentals in the $2.8 trillion municipal-bond market, even though “famed investor Warren Buffett had recently warned of a “terrible problem” ahead for municipal bonds.” When Mr. Buffett also testified to a Joint Congressional “Financial Crisis Inquiry Commission, which collected information on what caused the nation’s 2008 financial crisis, he stated his concerns about how municipalities will be able to pay for retirement and health benefits for public workers and that the federal government may ultimately be compelled to bail out states.
But since 2010, investing in municipal bonds has produced very high returns. The Fidelity Tax Free Bond Fund (FTABX), a mutual fund widely held by conservative older Americans, returned 11.98% over the last twelve months. But according to the Federal Reserve report, much of this performance may be due to Moody’s and other credit rating agencies “luring” investors into the municipal bond market by understating drastically understating the risks of default by 97%.
At approximately 7: PM EST on Friday evening, we were stunned when Moody’s stated that 10% of California cities have already “declared fiscal crises”. Under California Law, a requirement before a city is allowed to file for Chapter 9 municipal bankruptcy is to have declared a fiscal crisis. Moody’s stated that the declarations of emergency were “a reflection of the broader fiscal stress in the state” that may cause Moody’s to make “across-the-board” ratings downgrades of “California cities over the next month or two.”
Wall Street Journal assumed that Berkshire Hathaway’s sale, accomplished by liquidating municipal bond derivatives, “indicates that one of the world’s savviest investors has doubts about the state of municipal finances.” According to Jeff Matthews, a hedge-fund manager who personally owns Berkshire shares, “Mr. Buffett probably “doesn’t want this exposure anymore and is getting out while he can.”
Whatever the reason for making such a timely sale before bad news became public, the action by Warren Buffett and Berkshire Hathaway is sure to now frighten thousands of conservative elderly investors who have put their life savings in municipal bonds that will now be considered very risky. Cross-posted from Chriss Street’s blog.