Trouble looming for municipal bonds?

Warren Buffett may have doubts about municipal bonds, those boring tax-exempt investments that governments need to finance their operations and projects.

The Wall Street Journal reported Tuesday that the famed investor’s Berkshire Hathaway Inc. recently wound down a large bet on muni bonds. The decision to end credit-default swaps insuring $8.25 billion in bonds is seen as a sign “that one of the world’s savviest investors has doubts about the state of municipal finances,” the Journal reported.

While municipal defaults are considered rare, three California cities -- Stockton, San Bernardino and Mammoth Lakes -- have filed for bankruptcy this year.

More financial trouble could be on the way, according to Moody’s Investors Service. The ratings agency said last week it would embark on a wide-ranging review of California’s municipal finances.


Moody’s said it expects “more bankruptcy filings and bond defaults among California cities reflecting the increased risk to bondholders as investors are asked to contribute to plans for closing budget gaps,” according to the Associated Press.

If Moody’s predictions pan out, it would raise further questions about whether munis were as safe as previously thought.

A recent study by the Federal Reserve Bank of New York showed that municipal bond defaults have been more common than ratings agencies have reported.

From 1970 to 2011, one rating agency reported 71 municipal defaults, for example. But the Fed, using a more comprehensive database that included unrated muni bonds, showed 2,521 defaults in the same period.


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