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Whitney stays grim on muni bond outlook even as predicted default wave fails to show

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Meredith Whitney, the veteran Wall Street banking-industry analyst who late last year predicted a surge in municipal bond defaults in 2011, had a chance Wednesday to back away from or soften that as-yet-unfulfilled prophecy.

Instead, speaking on a panel at the Milken Institute’s annual global conference in Beverly Hills, Whitney stuck with her warning about a bigger storm coming in the tax-free muni market.

Whitney, head of Meredith Whitney Advisory Group in New York, helped trigger heavy selling in muni bonds in the fourth quarter and early part of this year with grim forecasts for state and local finances, which she said would lead to a rash of bond defaults in the $2.9-trillion muni market.

On CBS’ “60 Minutes” in late December she predicted “hundreds of billions” of dollars in muni defaults in 2011, including “50 to 100 sizeable defaults,” without naming names.

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But so far this year muni defaults have been normal or below normal -- a relative handful totaling in the hundreds of millions of dollars, not billions.

And after plunging from late-October to mid-January, muni bond prices overall have rebounded modestly, a rally that has accelerated over the last three weeks.

Muni bond yields, which move inversely to bond prices, have declined from two-year highs in mid-January as the market has calmed amid a steep drop in new issuance. The annualized yield on the Bond Buyer newspaper’s index of 40 long-term muni bonds nationwide (charted below) fell to a four-month low of 5.51% on Wednesday, down from a peak of 5.95% in mid-January.

Whitney has been blasted by many muni market professionals who insist that the vast majority of municipalities will make good on their debts, and that she fostered needless panic among small investors, particularly in bond mutual funds.

On a Milken conference panel on the outlook for financial markets, Whitney was asked by moderator Brian Sullivan about her “controversial” call on muni defaults.

Her response:

There’s really nothing controversial about that call, if you look at the numbers. States have been spending 2 1/2 times their tax receipts and that is going to be exaggerated when [federal] stimulus ends next month. What will happen is the states are cutting off aid to their local governments, which rely on them for over a third of their monies. Ohio has just cut off 25% of its aid to local governments and that’s prolific across all the states. The local municipalities have nowhere to go and their bias is to save their constituents before they save their bondholders. It’s an issue of willingess [to pay creditors] and ability, but I would say that willingness then trumps ability.

The entire panel session can be viewed on the Milken Institute’s website, here. Whitney talks about munis beginning at about the 2:20 minute mark and again at about 60:45.

Whitney, sounding exasperated at times, made no new predictions and didn’t repeat her December call, except to say that, “Facts are facts. This municipal issue is this municipal issue. You can criticize me for everything if you want. I’m just numb to it because I have more conviction on this than I’ve had on any single thing in my career.”

But it isn’t entirely clear if the “single thing” refers to the default call or to the broader issue of municipal finances, including more privatization of public assets, which Whitney had been talking about just before she made that remark.

-- Tom Petruno


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