Warren Buffett Worries About Muni Defaults. The Raters? Not So Much

June 15, 2010 · Leave a Comment

By Michael Corkery (WSJ Deal Journal)

Warren Buffett is warning of a “terrible problem” in municipal debt and has trimmed his investments. The cost of insuring municipal debt – through credit default spreads — has increased as some communities, such as Central Falls, R.I., have inched closer to insolvency.

So it seems like an curious time for Fitch Ratings to be “recalibrating” its municipal debt ratings, which has had the effect of lifting the ratings of thousands of municipalities.

Amy Laskey, who is a managing director at Fitch, tells Deal Journal that the recent recalibration took into consideration the fact that many municipalities are under intense stress, but “historically, the level of [muni] default was very minute as compared to other sectors.” Defaults account for a miniscule .002% of the $2.8 trillion muni-debt market in the past year, according to this Wall Street Journal article.

Fitch downgraded only 8% of the “tax-support” muni-debt, meaning the debt services is supported by tax revenue, in 2009 and is running at a comparable rate so far this year, Laskey said. (Fitch declined to provide Deal Journal the percentage of debt that it had downgraded so far this year).

“These are very long term obligations and we expect governments to meet those obligations,’’ says Laskey.

Does that make communities like Central Falls outliers or warnings of future problems? Central Falls, a small city with a large, impoverished immigrant population, was about to be taken over by a receiver largely because it can’t afford to pay the pensions of its city workers. (The state legislature just passed a law to prevent Central Falls and other municipalities from going into receivership)

It is one of only two communities in Rhode Island that has had its muni-debt downgraded by Fitch. (The other is Woonsocket.) With one of the nation’s highest unemployment rates, declining tax revenue, shrinking population, and large unfunded pension liabilities, Rhode Island could prove to be an outlier. And the problems in the muni-debt market may be contained to the weakest links.

But haven’t we seen this prologue before? In early 2007, investors were making similar predictions about how subprime mortgages would be contained to the riskiest, least credit worthy sector of the mortgage market. They also relied on history in formulating their opinions that the mortgage problems could be contained.

As investment advisers often warn: the past is no guarantee for the future performance.

Categories: News
Tagged: Warren Buffett, crisis, municipal debt, munis, ratings

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