2010-07-10

Municipal bonds threaten banking system

David Goldman looks at municipal debt on bank balance sheets in
The Bank-Insurance-Municipal Daisy Chain (Why the Federal Government Will Bail Out the States)
If municipal debt actually defaulted, the capital position of the banking system would be impacted, bank preferred debt might stop paying, and the holders of bank preferred debt–starting with the insurers–would be in serious trouble.
...Why buy munis? For all of Warren Buffett’s dire warnings about municipal finances, the fact is that the federal government can’t let major municipal debtors (at the level of states, for example) go under without also bringing down the banking system and everything else.

If it goes, it all will go together. That’s why munis ultimately will be bailed out. A Democratic administration whose core constituency is public employee unions will do everything in its power to keep them happy (and a Republican Congress, which we likely will have in 2011, may frustrate this). But ultimately it’s a matter of survival.
Just something to think about when someone says that a few defaults in the muni bond market won't cause any problems.

And don't forget Americas #1 investor also expects a bailout of municipal bonds and sells insurance on munis:

Socionomics—The Fall of Warren Buffett

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