Did Warren Buffet Sell Munis on Inside Information?

 

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.

Chriss Street and Paul Preston Co-Host “The American Exceptionalism Radio Talk Show” Streaming Live Monday Through Friday at 7-10 PM Click Here to Listen: http://www.mysytv.net/kmyclive.html

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FEDERAL RESERVE WARNS MUNICIPAL BONDS VERY RISKY

by Chriss Street

	Last week we first reported that California Sales Tax Revenue Nose Dives by 33.5% for the month of July, and then Moody’s Warns of Mass California Municipal Bankruptcies. During the “Great Recession” of the last four years, the California private sector was forced to slash

 employment and infrastructure spending, but the public sector made only modest cut backs. Much of this state and local spending was funded by selling municipal bonds to elderly investor who were told the “muni market” was safe, because the default rate is very low. But a new Federal Reserve study: “The Untold Story of Municipal Bond Defaults”, debunks that municipal bonds are safe investments and blames the Moody’s and S&P credit rating agencies for deceiving the public. This is sure to fan the flames of the growing panic among holders of California municipal debt

According to the August 15th report the by the Federal Reserve of New York:

“The $3.7 trillion U.S. municipal bond market is perhaps best known for its federal tax exemption on individuals and its low default rate relative to other fixed-income securities. These two features have resulted in household investors dominating the ranks of municipal bond holders.”

Individuals own three quarters of all municipal bonds; with $1.879 billion held directly and another $930 billion through investments in mutual funds. The Fed report emphasized that the perception of a low historical default history of municipal bonds has played a key role in “luring investors” to buy huge amount of municipal debt. The Fed specifically points out the perception of low default rates is due to widely advertised reports of low default rates by credit rating agencies. But the Fed determined the credit rating agencies have not told the whole story about the level of municipal bond defaults. Moody’s Investors Service (Moody’s) and Standard and Poor’s (S&P), the two largest bond rating agencies, provide annual default statistics for the municipal bonds. S&P reported that its “rated” municipal bonds defaulted only 47 times from 1986 to 2011. Similarly, Moody’s indicates that its “rated” municipal bonds defaulted only 71 times from 1970 to 2011. This compares much more favorably to the record of thousands corporate bond defaults during the same period:

But when the Fed tracked default listings from 1970 to 2011 through the Mergent and S&P Capital IQ data bases available to institutional investors, the municipal default rates during the same periods sky-rocket from 71 to 2,521 for Moody’s and 47 to 2,366 for S&P. The Fed calculated that there were a total of 2,527 municipal bonds that defaulted from the late 1950s through 2011; confirming that the real rate of municipal bond defaults was 36 times higher than Moody’s and S&P reported to the public.

The Fed warns that information regarding municipal bonds tends to be “self-selected”. Issuers stop seeking an annual rating from Moody’s and/or S&P, if their bonds are likely to not receive an “investment grade” rating. The Fed also determined “the municipal market is bifurcated into general obligation (GO) bonds and revenue bonds”. GO bonds carry a full faith and credit pledge of a state or local government, but revenue bonds are backed by a pledge of revenues raised from a specific enterprise, such as an airport, hospital, or school. According to the Fed, over the past sixteen years, 60% to 70% of newly issued municipal bonds were revenue bonds. Many of these projects appear to be politically justified to bankroll crony capitalist “sustainable” investments as industrial development bonds (IDB). IDB financings often involved new technologies or projects with no historical track record:

“the services offered by an alternative energy plant, pollution control facility, or other corporate-like entity may not be considered essential, because of the availability of other energy sources. Thus, these enterprises may have less potential to generate revenue.”

The bottom line of the Fed report is Moody’s and S&P are culpable for understating the risks to investing in the municipal bond market. Within 48 hours of the release of the Fed report, Moody’s acknowledged 10% of California cities have declared fiscal crises and disclosed: “across-the-board rating revisions are possible following a review of our ratings on California cities over the next month or two”. Based on the Fed report and Moody’s reaction, California and other municipal bondholders should be panicked.

Chriss Street and Paul Preston Co-Host “The American Exceptionalism Radio Talk Show” Streaming Live Monday Through Friday at 7-10 PM Click Here to Listen: http://www.mysytv.net/kmyclive.html

Moody’s Warns of Mass California Municipal Bankruptcies

by Chriss Street

The klaxon horn went off this evening for California municipal bondholders when Moody’s credit rating service issued a report stating that the plummeting financial condition of many California counties, cities, school districts and other government agencies will soon result in large numbers of municipal bankruptcy filings.  Concerned about their own potential liability for providing high ratings that encouraged conservative elderly Americans to invest in risky bonds; Moody’s announced they will undertake a wide-ranging review of municipal finances because of the growing insolvencies.

The Moody’s report comes just two days after we reported that “CALIFORNIA SALES TAX REVENUE NOSE-DIVES BY 33.5%.”  Stock brokers have often recommended California municipal bonds as very safe investments, due to historically low default rates and relatively stable finances.  But Moody's said that outlook is changing after the Chapter 9 Bankruptcy filings of Stockton, San Bernardino and Mammoth Lakes.

Moody’s is especially concerned with the growing attitude among many cash-strapped cities that filing bankruptcy to avoid paying bondholders, is politically more advantageous than cutting spending.  As a result, Moody’s will re-assess the financial condition of all California cities, which issues about 20 percent of the municipal bond volume nationwide, "to reflect the new fiscal realities and the governmental practices." 

The Moody’s report said the credit rating service will also examine the outlook for municipal bonds in other troubled states.  Robert Kurtter, Managing Director of public finance at Moody's, would not say which states they will review, though Kurtter mentioned Michigan and Nevada as possibilities. 

Tonight’s report noted that many cities across the nation are in financial distress, but emphasized that a greater share of bankruptcies are expected to come from California.  Local officials were quick to try to downplay this grim forecast.  Chris McKenzie, Executive Director of the League of California Cities responded: "Moody's has an obligation to review changing circumstances, but we would just suggest that their assessment of the framework and ground activities is perhaps exaggerated.”

Tom Dressler, spokesman for California State Treasurer Bill Lockyer, cautioned against overacting to only three bankruptcies from California's 482 cities: "No city's going to blithely skip into bankruptcy court to avoid its obligations." Mr. Dressler called the report "a little hyperbolic."

Moody’s detailed that over 10% of California cities have already declared fiscal crises, with the most troubled areas lying inland in the middle of the state and east of the Los Angeles area.  Mr. Kurtter said the declarations of emergency were "a reflection of the broader fiscal stress in the state" and went on to warn that Moody's may issue an  “across-the-board rating revisions are possible following a review of our ratings on California cities over the next month or two” for all California cities.  Chris McKenzie acknowledged that such a move "would have a terrible impact on taxpayers."

Moody’s highlighted growing doubts that cash-strapped cities are willing making good-faith efforts to pay their bonds debts in full.  Former Treasury official Paul Rosenstiel, a Principal at DeLaRosa & Co municipal bond investment-banking firm in San Francisco stated: "Credit analysis is based on the ability to pay and the willingness to pay.  Investors have historically assumed that cities are willing to pay their debts because they want continued access to the bond market” … “What is being considered is whether the willingness to pay is something that needs to be factored in more than in the past — and if so, how would you measure it?"

California cities already pay higher interest rates to borrow money from municipal bond investors because the state has the second lowest bond rating in the nation, only Louisiana is lower.  But if any city’s credit rating is cut to the “junk bond” level, rates would rise so high that the city would be forced to file bankruptcy.   Most cities are already are financially deteriorating, because of a steep drop in tax revenue. 

The Moody’s report is raising alarms for city leaders who fear it may trigger a market panic.  "Every city in the state is looking on with some concern," said Dave Vossbrink, spokesman for the city of San Jose.  "Governments of all kinds borrow money, usually to build infrastructure that lasts a long time.  It's like getting a mortgage to build roads, a sewage plant, whatever it might be."  Mr. Vossbrink emphasized that San Jose has cut laid off cops and closed libraries.  Residents also recently voted to cut public pension benefits for city workers, but those cuts may not be enough prevent a downgrade.

Moody's said it will conduct in-depth financial stress tests for all California cities in the coming weeks and issue appropriate downgrades in September.  The timing of the Moody downgrades may be especially devastating for the California state budget.  Governor Jerry Brown kicked off his drive this week to save the state’s solvency by encouraging voters to pass an $8 billion tax increase initiative on the November ballot.  But bad press and rising bankruptcies is sure to undermine voter support.   

Chriss Street and Paul Preston Co-Host
“The American Exceptionalism Radio Talk Show”
Streaming Live Monday Through Friday at 7-10 PM
Click Here to Listen:  http://www.mysytv.net/kmyclive.html

The Train the Broke California’s Back

By Chriss Street

The State of California was already facing a $19 billion budget deficit, had shorted K-12 public schools $8 billion and are releasing imprisoned rapists into “community probation” when the California Legislature’s Democratic majority voted last week to approve selling $4.6 billion in new state bonds to build 130 miles of railroad track through some of the most uninhabited farm country in Central California.  The arrogance of the leveraging the already insolvent state caused a volcanic public outrage, but the Legislature and Governor Jerry Brown were desperate to get their paws on $3.3 billion in federal grants from the Obama Administration.

But in a shocking development, Moody’s Investor Services, who was expected to provide the credit rating to justify selling the debt, may have just torpedoed California’s credit rating by tripling their estimate of the state’s unfunded public pension liability from $38.5 billion to $109.1 billion liability and raising the annual cost of state pension funding by $7.3 billion.    

California has long been ground zero for financially dysfunctional government.  Under the California State Constitution, the Legislature is required to approve a “balanced budget” each year.  At the start of the last year’s budget on July 1, 2011, California had an $8.2 billion budget deficit carry-over from the prior year.  No problem for Sacramento political magicians to balance a budget, they simply estimated the state would collect $9.7 billion in capital gains taxes from the Facebook initial public offering.  Twelve months later, the state has collected less than $1 billion from Facebook and the deficit has grown by another $1.4 billion to $9.6 billion.  This year the Legislature passed another dicey “balanced budget” on the expectations voters would approve in November $8 billion in new sales and income taxes. 

The key to California politicians being able to continue their Ponzi spending far above the state’s revenues, has been the willingness of ratings agencies, like Moody’s, to dutifully collect huge consulting fees for providing the state with an “investment grade” credit rating.  Armed with the Moody’s “Good Housekeeping Seal of Approval”, municipal bond investors have been willing to loan California huge amounts of cash.    

But the bogus choo choo bonds may have been so toxic even for Moody’s high tolerance for government shenanigans; they were the proverbial “straw that broke the camel’s back”.  If Moody’s issued an investment grade credit rating and the railroad bonds eventually default, the firm would undoubtedly be sued for billions of dollars by lots of angry retired people who tend to be the main buyers of municipal bonds. 

      

This newfound conservatism by Moody’s comes at a very in-opportune time for the State and its 58 counties and 478 cities.  Each year, California governments have borrowed huge amounts of money by selling low cost municipal bonds in late July to finance the period until they collect the majority of their tax revenues in December and April.  The State of California was expecting to borrow $28 billion and municipal governments were anticipating borrowing anther $50 billion.   

But any downgrades of the state or municipality debt from investment grade to “junk bond”, would send the cost of borrowing up to Greek like levels of 20%.  This appears to be exactly what just happened to San Bernardino, California and forced the city to file for an emergency Chapter 9 municipal bankruptcy.  According to Los Angeles Times:

“The city's fiscal crisis has been years in the making, compounded by the nation's crushing recession and exacerbated by escalating pension costs, lucrative labor agreements, Sacramento's raid on redevelopment funds and a city reserve that is tapped out”.

This same language could apply to most of the cities and counties in California over the last few years.  The real reason for the collapse of San Bernardino and the growing panic is Moody’s was about to downgrade the city’s credit rating to junk.  With state and most local governments running out of cash, there will be more bankruptcies in California.  It looks to me that it was the train that broke California’s back.

Chriss Street will be in Studio with Paul Preston on “The Inside Education”; Streaming Live from Monday July 9^th to Friday July 13^th.  Click Below to listen between 7-10 PM each night:  http://www.mysytv.net/kmyclive.html