The WSJ reports tonight that Warren Buffett’s Berkshire Hathaway has terminated $8.25 billion in municipal CDS contracts (derivatives insuring municipal bonds in the event of default by the municipality)- 50% of his overall position!
As the announcement likely just gave the remaining 50% of Berkshire’s position a massive haircut (Buffett’s sale is quite likely to initiate a massive panic for the exits in the muni market), perhaps Buffett should have invested a few million into convincing the ISDA to treat the upcoming tsunami of US muni bankruptcies like a Greek bankruptcy and label them ‘voluntary credit restructuring events’.
In any case, Buffett’s drastic move indicates the long awaited US muni bankruptcy crisis is likely imminent.
From the WSJ:
A decision by Warren Buffett’s Berkshire Hathaway Inc. to end a large wager on the municipal-bond market is deepening questions from some investors about the risks of buying debt issued by cities, states and other public entities.
The Omaha, Neb., company recently terminated credit-default swaps insuring $8.25 billion of municipal debt. The termination, disclosed in a quarterly filing with regulators this month, ended five years early a bullish bet that Mr. Buffett made before the financial crisis that more than a dozen U.S. states would keep paying their bills on time, according to a person familiar with the transaction.
The insurance-like contracts, which required Berkshire to pay in the event of bond defaults, were originally purchased by Lehman Brothers Holdings Inc. in 2007, more than a year before the Wall Street firm filed for bankruptcy, the person said.
Details of the termination, with the Lehman Brothers estate, weren’t disclosed. It isn’t clear whether Berkshire’s move will leave the company with a profit or loss on the wager. Mr. Buffett, Berkshire’s 81-year-old chairman and chief executive, declined to comment.
While the WSJ states it isn’t clear whether Berkshire made a profit or loss on the CDS contracts, based on the WSJ’s chart, ZH believes Berkshire has lost hundreds of millions of dollars on the position.
It is fairly safe to assume that Buffett will close out with a substantial loss. Having sold over $8 billion in insurance on what appears to be 10 year duration CDS at 20 bps, the fact that he is unwinding at a spread four times wider, at a massive DV01, means that there is no way the roll alone would have offset the blow out in spread. As a result it is fair to assume that hundreds of millions in P&L were lost as a result of this trade.
If Warren Buffett is locking in hundreds of millions in losses on a trade- and guaranteeing much more massive losses on the remaining 50% of the trade, The Oracle must foresee massive imminent bankruptcies in the muni market.
But we thought Ben and Timmy had informed us the recovery was progressing slowly?