Stockton, California has filed for bankruptcy. In testimony before the U.S. Financial Crisis Inquiry Commission in June 2010, Warren Buffett, The Oracle of Omaha, predicted a “terrible problem” for municipal bonds in coming years. A portion of that prediction came true on June 28 with Stockton, California becoming the largest city ever to declare bankruptcy. On that day, the town of Stockton, CA, filed for Chapter 9 bankruptcy protection. This is not the first town to file for bankruptcy with outstanding bonds, however its aggressive attitude toward bondholders has those in the municipal bond market concerned. Warren Buffett, billionaire chairman of Berkshire Hathaway, Inc., has continued to express concerns about the number of municipal bankruptcies happening around the nation.
Kelly Nolan and Mike Cherney writing for WSJ.com point out the dangers for current bondholders. Stockton missed bond payments earlier this year and does not plan to make any further payments during its reorganization. This lack of concern for making debt payments is unusual. Cities such as Vallejo, CA and Central Falls, RI, are going through bankruptcy and have reported that they are making every effort to keep their bondholders whole. Few cities, towns, villages and counties actually file for bankruptcy as it could make it more difficult to get funding in the future. Specifically, only 51 such entities have filed since 1980 with a quarter of them since the economic recession in 2008. Stockton City Manager Bob Deis reports massive spending and staffing cuts already and claims that “further reductions to service levels would not only jeopardize the safety of residents, they also would severely limit this city’s chances for economic improvements.” While the number of municipal issuers defaulting on their bonds has fallen since 2010 according to Municipal Market Advisors, Buffett thinks that the “stigma” of bankruptcy as a deterrent is much less when sizable municipalities like Stockton, CA, thumb their nose at creditors. The stress on cities and municipalities has been strained by rising costs and dropping tax revenues. This stress has become even more acute considering that many cities and municipalities are facing serious shortfalls in funding pension obligations and declare bankruptcy when payments cannot be made. Buffet’s warnings need to be seriously heeded by investors and more care needs to be exercised in making a decision to buy municipal bonds. The days of assuming that a municipal bond investment must be okay by its very nature are gone.
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