Buffett's muni move: Nothing risked, something gained
— -- Warren Buffett's offer to stand behind municipal bond payments is like offering auto insurance to a driver with a perfect record.
Municipal bonds, or munis, are one of largest and safest corners of the bond market. There are about $1.7 trillion worth of such bonds outstanding, says the Securities Industry and Financial Markets Association. Munis are sold mainly by state and local governments to pay for projects such as roads, schools and hospitals.
Munis are popular with high-income investors because the payments are often tax-exempt. But they're also relatively safe. If a city gets into financial trouble, it can charge higher taxes, close libraries or parks.
There have been some high-profile muni bond debacles, including Orange County in the 1990s. Still, only about one muni bond a year, on average, has gone into default over the past 40 years, says Bill Larkin, a bond investor at Cabot Money Management. Less than 0.25% of muni bonds historically go into default, says Michael Decker at SIFMA. There are 2 million munis outstanding.
Excluding riskier muni bonds issued for special purposes in partnership with outside companies, such as some toll road projects, the muni default rate is essentially zero, Decker says.
Compare that with the 35,000 business bankruptcy filings each year on average this decade, according to BankruptcyData.com.
Buffett may not be taking a giant risk in offering insurance to the three main insurers that stand behind muni payments. Even so, the offer exposes vulnerabilities in the muni market, including:
•Stress on some lower-rated munis. Thanks to their relative safety and preferred tax status, cities and states can borrow inexpensively: Muni bonds are yielding roughly 3.4% for a bond maturing in 10 years, S&P says. That's even cheaper than the 3.78% 10-year Treasury yield.
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