Wednesday, December 22, 2010

Meredith Whitney and the Municipal Bond Market


If you've been at the investment management business for a while - as Random Glenings has been - you can recall numerous situations where some analyst makes their fame and fortune through making a market prediction that appears to be outrageous at the time but turns out to be true.

For example, when I first got into the business in 1982, a technical market analyst named Joe Granville correctly predicted that a major stock market correction was imminent.

Elaine Garzareilli was at Lehman Brothers when, in August 1987, she correctly forecast a huge market downturn was near - and sure enough, October 1987 saw the markets drop by -25% in a single day.

More recently, perma-bears like Nouriel Roubini from New York University and economist David Rosenberg (formerly of Merrill Lynch) correctly foresaw the economist crisis in 2008.

But what do all of these folks have in common? They never change their tune. They all attempted to repeat their forecasting feat, and make more outlandish predictions that turn out to be wildly wrong.

I remember talking to a client who told me a story about his grandfather. Right before the crash of 1929, his grandfather had correctly foreseen the crash, and sold all of his stocks.

Problem was, once his grandfather re-entered the market, he kept seeing warning signs ahead, and would try to repeat his feat of 1929 over and over again, only to watch the stock market roar ahead.

Which brings me to Meredith Whitney.

Ms. Whitney is a good bank analyst who correctly predicted the problems in the banking sector in 2007 while she was at Oppenheimer. She was particularly prescient on her views on Citigroup, and forecast the huge drop in price and massive dividend cut that eventually occurred.

So Ms. Whitney took her newly-found fame and went off to start her investment management consulting firm.

She turned her attention to the municipal market and found municipal finances in tough shape (quelle surprise!). She then went public with some very dire predictions for the municipal bond market, and even appeared on 60 Minutes last Sunday (did I mention that Ms. Whitney is very attractive?).

I've gotten a few calls on her appearance, and sufficient to say that I do not agree at all with Ms. Whitney. Today I saw a column on Bloomberg that does a pretty good job at summarizing my thoughts.

Here's an excerpt, with the full link below:

There will be between 50 and 100 “significant” municipal bond defaults in 2011, totaling “hundreds of billions” of dollars.

So said banking analyst and new municipal bond expert Meredith Whitney on the “60 Minutes” show on Sunday, in perhaps the boldest, most overreaching call of her career.

Hundreds of billions of dollars? The one-year record, set in 2008, is $8.2 billion. You can see how an estimate of “hundreds of billions” would get people’s attention...

...This isn’t the Whitney scenario. No, she envisions between 50 and 100 -- or more -- counties, cities and towns making the choice to renege on their bonded debt.

My question is: Why?

Why would a governmental entity go out of its way to provoke or alienate its best source of finance? In the old days you might say that bondholders were a distant class of banks and plutocrats mainly centered in the Northeast. That’s no longer true, and hasn’t been since at least the passage of the Tax Reform Act of 1986, which made bonds less attractive for banks and insurance companies, among other things. Today, a city’s bondholders might live in the municipality itself, and almost certainly reside within the state.

Debt Service

Why would a governmental entity choose to default on its bonds, especially if they make up a relatively small proportion of its costs?

“Debt levels for U.S. local and state governments are relatively low, with annual debt service representing a relatively small part of budgets,” Fitch Ratings said in a special report in November.


Meredith Whitney Overreaches With Muni Meltdown Call: Joe Mysak - Bloomberg.com