by Felix Salmon
March 01, 2009 | about stocks: AXP / BRK.A / BRK.B / GE / GS / WFCBerkshire Hathaway Annual Letter to Shareholders 2008 - Read the latest Berkshire Letter
Warren Buffett is often described as one of the greatest stock-market investors of all time. But as Jeff Matthews works out, his stock portfolio, built up over decades, is now worth just $37.1 billion -- which is exactly the same as its nominal cost basis. Buffett's total return on his stock market investments, right now, is zero, excluding dividends. That's largely because they've dropped almost 25% year-to-date, compared with a fall of 18.6% in the S&P 500.
Now Buffett isn't the kind of guy who worries about underperforming in any given two-month period. But he's clearly better at picking outperformers than he is underperformers. He had to liquidiate some of his stock-market portfolio in 2008 in order to make investments in GE, Goldman Sachs and Wrigley. Which stocks did he sell? "Primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips".
With hindsight, of course, the main stock he should have sold, before it entered a truly torrid 2009, was Wells Fargo. And selling Wells -- or American Express, for that matter, which has also sunk like a stone of late -- would have made a lot of sense, given that he was loading up on financials in the form of Goldman and GE securities. But instead he chose to go massively overweight financials, and sold instead safe-and-reliable defensive stocks. Weird.
That said, Buffett still writes a great chairman's letter. The highlight this year is his discussion of moral hazard in municipal bond insurance, which is worth quoting at length:
The rationale behind very low premium rates for insuring tax-exempts has been that defaults have historically been few. But that record largely reflects the experience of entities that issued uninsured bonds...
A universe of tax-exempts fully covered by insurance would be certain to have a somewhat different loss experience from a group of uninsured, but otherwise similar bonds, the only question being how different. To understand why, let's go back to 1975 when New York City was on the edge of bankruptcy. At the time its bonds - virtually all uninsured - were heavily held by the city's wealthier residents as well as by New York banks and other institutions. These local bondholders deeply desired to solve the city's fiscal problems. So before long, concessions and cooperation from a host of involved constituencies produced a solution. Without one, it was apparent to all that New York's citizens and businesses would have experienced widespread and severe financial losses from their bond holdings.
Now, imagine that all of the city's bonds had instead been insured by Berkshire. Would similar belt- tightening, tax increases, labor concessions, etc. have been forthcoming? Of course not. At a minimum, Berkshire would have been asked to "share" in the required sacrifices. And, considering our deep pockets, the required contribution would most certainly have been substantial.
Local governments are going to face far tougher fiscal problems in the future than they have to date...
When faced with large revenue shortfalls, communities that have all of their bonds insured will be more prone to develop "solutions" less favorable to bondholders than those communities that have uninsured bonds held by local banks and residents. Losses in the tax-exempt arena, when they come, are also likely to be highly correlated among issuers. If a few communities stiff their creditors and get away with it, the chance that others will follow in their footsteps will grow. What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?
It's entirely possible that munis might well end up behaving much like CDOs: they never default, until they all do.
This time last year, Jesse Eisinger wrote a column all about how muni bond insurance was a racket, and an amazing business to be in:
How is it that municipalities almost never default on their debt? When communities face trouble and consider filing a claim on their bond insurance, they think twice. They don't want to risk being downgraded or shut out of the capital markets for future bond sales. It's the same rationale that might keep you from filing an insurance claim if you have a fender bender. You could figure that it's better to eat the cost of the repair than risk having your premium go up.
This is true of the first municipality to default. But it's not true of the fourth. Once a few munis have started defaulting, they're all going to be "downgraded or shut out of the capital markets for future bond sales", whether they default or not. So at that point, they might as well just default. Municipal bond insurance, it turns out, might well be yet another one of those trades which makes lots of money until it blows up. And those credit spreads on muni bonds might be more justifiable than the likes of Eisinger might have you believe.
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