Now that three California towns have declared bankruptcy in the past few weeks, the mainstream media is abuzz with headlines of imminent doom for state and local governments. Adding fuel to the fire were Warren Buffett’s comments on Bloomberg TV about how cities may find it easier to declare bankruptcy after seeing others do it:
“The stigma has probably been reduced when you get very sizeable cities like Stockton or San Bernardino to do it,” Buffett, 81, said in an interview today on “In the Loop with Betty Liu” on Bloomberg Television. “The very fact they do it makes it more likely.”
He said the nation isn’t on the brink of hundreds of billions of dollars in defaults, as banking analyst Meredith Whitney predicted in 2010. “I don’t think we’re at the precipice,” Buffett said. “People will use the threat of bankruptcy to try and negotiate, particularly pension contracts, with their employees.”
Unlike Buffett, I’m not sure that public unions will yield to local politicians who wave the threat of municipal bankruptcy at them. As soon as there is a case when labor and pension contracts are actually crammed down in a bankruptcy proceeding, then public unions might start to worry. The closest muniland came to this kind of restructuring occurred in the bankruptcy proceeding in Central Falls, Rhode Island. There, labor and pension contracts were modified, but its situation is unique because of Rhode Island’s law prohibiting any haircuts for bondholders. Unions had to take all the losses in the bankruptcy proceeding because no one else would.
Furthermore, Buffett might be talking his book here. Bloomberg reports that Berkshire Hathaway held municipal bonds valued at about $3 billion as of March 31 – about 9 percent of its fixed-maturity portfolio – and as much as $16 billion in derivatives tied to such debt. That his company’s position in muniland CDS is much bigger than his position in municipal cash bonds indicates that he is very pessimistic about muniland’s prospects and is willing to bet on that outlook.