Adding detail and nuance to April 11's "Warren Buffett: Avoid States With Large Unfunded Pension Liabilities", a repost from February 2019. This memory triggered by Brookfield's strategic default in D.C.:
Mr. Buffett, through his insurance companies, guarantees a few of the
country's municipal bonds. Muni holders are often in conflict with
public employee unions and/or public employee pension overseers,
especially in the event of a municipal bankruptcy.
These guarantees usually take the form of credit default swaps.
In addition Berkshire Hathaway carries a small amount of munis as an asset on the consolidated balance sheet.
Warren pays attention to this stuff. His 2008 Letter to Shareholders is a
mini-masters course in moral hazard in the muni biz. Some copied out
after the jump
And the headline story from the San Francisco Business Times:
Warren Buffett described unfunded public pensions as a “disaster” that companies and individuals must consider when deciding where to expand or move.While corporate America’s traditional, defined-benefit pension plans are no longer the problem they were 10 or 20 years ago, “in the public sector, you know, it’s a disaster,” Buffett told CNBC this week in discussing Amazon’s (NASDAQ: AMZN) decision to ditch New York City for a major expansion.California’s unfunded public pensions are a hot topic, with taxpayers on the hook for making up any shortfalls in employee contributions or investment returns.
“If I were relocating into some state that had a huge unfunded pension plan, I'm walking into liabilities," Buffett said. "'Cause I mean, who knows whether they're gonna get it from the corporate income tax or my employees — you know, with personal income taxes or what. That liability isn't gonna — you can't ship it offshore or anything like that. And those are big numbers, really big numbers.
The class begins on page 13 of the 2008 letter. The following is from page 14:“The politicians are the ones that really haven't attacked it in a good many states. And when you see what they would have to do, I say to myself, ‘Why do I wanna build a plant there that has to sit there for 30 or 40 years?’” he said. “They will come after corporations, they'll come after individuals. They're gonna have to raise a lotta money.”...MORE
...The rationale behind very low premium rates for insuring tax-exempts has been that defaults have historically been few. But that record largely reflects the experience of entities that issued uninsured bonds. Insurance of tax-exempt bonds didn’t exist before 1971, and even after that most bonds remained uninsured.
A universe of tax-exempts fully covered by insurance would be certain to have a somewhat different loss experience from a group of uninsured, but otherwise similar bonds, the only question being how different.To understand why, let’s go back to 1975 when New York City was on the edge of bankruptcy. At the time its bonds – virtually all uninsured – were heavily held by the city’s wealthier residents as well as by New York banks and other institutions. These local bondholders deeply desired to solve the city’s fiscal problems. So before long, concessions and cooperation from a host of involved constituencies produced a solution. Without one, it was apparent to all that New York’s citizens and businesses would have experienced widespread and severe financial losses from their bond holdings.
Now, imagine that all of the city’s bonds had instead been insured by Berkshire. Would similar belt-tightening, tax increases, labor concessions, etc. have been forthcoming? Of course not. At a minimum, Berkshire would have been asked to “share” in the required sacrifices. And, considering our deep pockets, the required contribution would most certainly have been substantial.
Local governments are going to face far tougher fiscal problems in the future than they have to date.The pension liabilities I talked about in last year’s report will be a huge contributor to these woes. Many cities and states were surely horrified when they inspected the status of their funding at year end 2008.
The gap between assets and a realistic actuarial valuation of present liabilities is simply staggering.When faced with large revenue shortfalls, communities that have all of their bonds insured will be more prone to develop “solutions” less favorable to bondholders than those communities that have uninsured bonds held by local banks and residents. Losses in the tax-exempt arena, when they come, are also likely to be highly correlated among issuers.
If a few communities stiff their creditors and get away with it, the chance that others will follow in their footsteps will grow. What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?
Insuring tax-exempts, therefore, has the look today of a dangerous business – one with similarities, in fact, to the insuring of natural catastrophes. In both cases, a string of loss-free years can be followed by a devastating experience that more than wipes out all earlier profits. We will try, therefore, to proceed carefully in this business, eschewing many classes of bonds that other monolines regularly embrace....MUCH MORE
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Considering the apparent acceleration of muni bankruptcies in
California, Vallejo in 2008 and then Stockton, Mammoth Lakes
and San Bernardino, combined with talk of "strategic bankruptcy"
Berkshire saw the problem and acted, fast.