Warren Buffett notes that cities and states are not immune to the consequences of the deflationary spiral currently afflicting the larger economy.

In addition, the bills are beginning to come due for years of profligacy in promises of post-retirement benefits for public employees.

With this unprecedented fiscal strain, he warns, "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."

In the coming crisis of muni credit, outcomes for holders of insured muni bonds are likely to be worse than for uninsured bondholders.

The idea is that the latter business, subject to minimal or at least manageable losses, can go forward and prosper, free from the capital drag and reputational injury caused by their disastrous adventures in structured finance and structured credit.

severe fiscal stresses in the world of investment grade muni issuers have been isolated, episodic and rare. So, bond insurers’ abilities proactively to manage the credit risks in their public finance portfolios have been valuable only at the margin.