Billionaire super-investor Warren Buffett said July 16 that the recent bankruptcy filings of three California municipalities could create a climate where cities would more easily consider Chapter 9 as an option for alleviating debt woes.
Three cities file Chapter 9
Over the past month, three California towns have filed for bankruptcy. First it was Stockton, then the resort town of Mammoth Lakes. On July 10, San Bernardino also took the plunge.
Buffett, who two years ago warned about the risk of investing in traditionally-safe municipal bonds, spoke with Betty Liu on Bloomberg’s “In The Loop” television program. He said:
“The stigma has probably been reduced when you get very sizable cities like Stockton or San Bernardino to do it. The very fact they do it makes it more likely.”
San Bernardino is a large community of about 210,000, located east of Los Angeles. Stockton, even larger, is a community of 292,000, located east of San Francisco.
Not at the precipice
Buffett also said that he does not believe the filings will lead to American municipalities defaulting on hundreds of billions of dollars worth of debt.
“I don’t think we’re at the precipice. People will use the threat of bankruptcy to try and negotiate, particularly pension contracts, with their employees.”
When it is observed that these cities do not come to a screeching halt as a result of the filings, Buffett continued, others will surely follow.
“Once people find that the city works the next day, it makes it easier for the city council next time they have a problem with pensions — or whatever it is — just to say, ‘Well, we’ll declare bankruptcy.’”
Some experts disagree
Others, however, believe the stigma still remains, keeping most municipalities from considering the move. John Hallacy, head of Municipal Research at Bank of America Merrill Lynch Global Research, said:
“It’s too early to say that there’s a lack of stigma. Municipal bankruptcy is a gut-wrenching process. There’s nothing easy about it.”
Municipal bond risks
At one time, municipalities sold bonds to fund public works projects. These investments were safe, because elected officials did not want to risk defaulting on voters. However, their very safeness led insurance companies to cover them against default for small premiums.
Today, elected officials are not so worried about disappointing constituents/investors because they know companies like Berkshire Hathaway, which Buffett chairs, will be obligated to step in and pay the bill for defaults.