2010: Is the municipal bond market going to crash?
CAROL LOOMIS: This question is about municipal bonds. Municipal bond defaults, on the scale you described in the 2008 letter, have so far not materialized.
To what extent will we see municipalities default outright in the next five to 10 years? Will the bond insurance companies be able to swallow the losses? Will there be federal bailouts of states?
And considering all of these risks, should investors be getting paid more than they already are for holding municipal bonds?
WARREN BUFFETT: Well, if the bonds are insured by Berkshire, you don’t need to worry at all. (Laughs)
But we’re not insuring a lot of bonds currently, because we don’t think the premiums are appropriate, which gets to the question.
Just the other day, within the last few days — you’ve probably read about it in the papers — Harrisburg, Pennsylvania, defaulted on a relatively small amount of bonds.
And the bond insurer, named Assured Guarantee, starts paying the interest.
And Harrisburg may get things worked out in a week, you know, and they may not. There’s certainly some incentive to do that. And if they do get it worked out, the bond insurer’s not too much on the hook.
But what you worry about is correlation in this field, that if one entity defaults — and particularly if nothing terrible happens, that the police are on the street the next day, and the fire trucks still go to fires and all that — and people start thinking, “Why should I have a great fiscal reputation when I can have lower taxes and still have all the services I need?”
It’s very hard to tell how that will play out. I personally think it would be very hard, in the end, for the federal government to turn away a state that was having extreme financial difficulties when they’d, in effect, gone into General Motors and various other entities and saved them.
I don’t know exactly how you would tell the governor of state X that you were going to stiff-arm him, and when you’d participated in so many other bailouts of corporations.
But who knows what would happen, and who knows how contagious it would be? The big thing you worry about if you’re a bond insurer is contagion.
Obviously the bond insurers — except for Berkshire — the bond insurers, in my view, have got extraordinary liabilities in relation to their capital.
And virtually every one of them either failed or effectively failed — had to spin off a bad bank versus a good bank type of thing, or something like that — with merely the troubles they encountered when they got into structured securities.
And I think they’ve had a very optimistic attitude toward what could happen in the field. But I don’t know the answer on what default rates are going to be over the next few years.
I knew that I felt I was getting paid fairly for taking that risk on a year-and-a-half ago, and I don’t feel that we’re getting offered a premium that’s fair now, so we’re going to let somebody else do it.
Charlie?
CHARLIE MUNGER: Yeah, with the municipal bonds, I would try and invest in places that were both prosperous and disciplined.
You want to invest in the prosperous, because Ben Franklin was right when he said, “It’s hard for an empty sack to stand upright.”
And you want to invest in the disciplined places because integrity still matters. It’s not very difficult, it’s not very complicated.
WARREN BUFFETT: But you could argue that in a country, if the undisciplined are not being punished for being undisciplined, that the taxpayers in disciplined areas would say, “Wait a second. You know, why should we keep up a record of financial prudence and all that and pay our bills when other guys aren’t paying their bills?”
CHARLIE MUNGER: Well, there’s no question about the fact that bad behavior is contagious. That’s the way human nature works. But I’d still rather be with the disciplined, —
WARREN BUFFETT: Yeah.
CHARLIE MUNGER: — prosperous people.
WARREN BUFFETT: Number 6.
CHARLIE MUNGER: That’s why I like the Berkshire meeting. (Laughter)
WARREN BUFFETT: That, and free fudge. (Applause)