Warren Buffet, Credit Default Swaps, and State Bankruptcy

I get nervous when Warren Buffet decides to get out. According to this report at Reuters, Berkshire Hathaway Inc. will terminate $8.25 billion in credit default swap (CDS) protection it has sold on municipal debt. In short, it's time to short government debt.

Earlier this year I posted here that state-level insolvency in the U.S. was coming dangerously close to state-level default. And I argued here that Congress should amend the Bankruptcy Code to provide for state-level bankruptcy. Due at least in part to the noise of election season both topics have subsisted largely below the radar of the media, mainstream and otherwise. But Warren Buffet's Berkshire Hathaway has been paying attention and decided to get out of the government debt CDS market.

I'm currently writing something tentatively titled "Financial Contracts for Dummies" (e.g., me) so I won't try to explain here what a CDS is. Suffice it to say, with these CDS's, Berkshire Hathaway was originally betting that local (and state) governments would not default. Warren Buffet is now sending a strong signal by getting out of the market and liquidating his current positions that he perceives the risk of such defaults to be increasing.

The response to this signal is to sell such debt before the market tanks and, if you really like risk, sell it short now on the hope that it will tank before it's time to deliver.