Explaining Southern California's economy

Things are getting tense in the municipal bond market

Residents make their way in and out of t

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San Bernardino is the latest California city to declare bankruptcy. Is this the beginning of the end of the once-sleepy, rock-solid municipal bond market?

It's hard to tell if this is just general nervousness after a rally or a legitimate reason to worry about an impending wave of defaults on municipal bond debt — something that has basically never happened. But in the span of a few days, billionaire investor Warren Buffett has unloaded $8.25-billion in credit default swaps on muni debt.

Buffett's Berkshire Hathaway sold the CDS to Lehman Brothers prior to the investment bank's epic bankruptcy four years ago, a Chapter 11 for the ages considered by many to be the thing that kicked off the Great Recession. Buffett's CDS amounted to a bet that cities wouldn't default on their debts — a prediction that for the most part has turned out the be true.

However, over the past few months, three California cities — Stockton, Mammoth Lakes, and San Bernardino — have declared bankruptcy. The ratings agency Moody's has stressed that muni defaults are exceptionally rare (as long as the bonds are rated; the Federal Reserve Bank of New York recently noted that unrated defaults happen more frequently, although they're far from common). But Moody's has also announced that it's conducting a review of the debt of cities in California, in light of recent events.

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