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"There's not a doubt in my mind that you will see a spate of municipal-bond defaults," the banking analyst Meredith Whitney, nodding her head, said on a Dec. 19 segment of CBS's 60 Minutes.
"How many is a spate?" correspondent Steve Kroft asked.
"You could see 50 sizable defaults, 50 to 100 sizable defaults, more," said Whitney, 41, who made her name covering bank stocks. "This will amount to hundreds of billions of dollars' worth of defaults."
Those two sentences set off a month of fireworks in the almost $3 trillion muni market. California Treasurer Bill Lockyer called the prediction "apocalyptic arm-waving." The National League of Cities' research director cited her "stunning lack of understanding." Pimco's William H. Gross, who runs the world's biggest bond fund, simply said he doesn't subscribe to the "theory."
James A. Bianco, the president of Bianco Research in Chicago, compares the attacks on Whitney with the fury directed at New York University economist Nouriel Roubini, who in 2006 predicted the financial crisis. "Everybody was lining up to tell us why Roubini was wrong, and he wasn't," Bianco says.
Meanwhile, investors pulled about $4 billion from municipal-bond mutual funds in the week ended Jan. 19, the most since Lipper U.S. Fund Flows started compiling the data in 1992. Investors have withdrawn money from muni funds for 11 straight weeks, as of Jan. 26, according to Lipper, taking out $22.5 billion. Returns on municipal securities fell the most in 16 years in the fourth quarter of 2010, according to the Merrill Lynch Municipal Master Index. The cost for AAA-rated issuers to borrow for 30 years climbed by almost a third, to 5.09 percent on Jan. 17, from 3.85 percent on Nov. 1.
"We've got terrified clients who call constantly and want reassurance because Meredith said there's going to be hundreds of billions of dollars of defaults," says David R. Kotok, chief investment officer at Cumberland Advisors in Vineland, N.J., which manages more than $1.5 billion.
While Whitney is not retreating from her prediction, she says she doesn't have specific numbers to back it up. "Quantifying is a guesstimate at this point," she told Bloomberg on Jan. 30. "I was giving an approximation of a magnitude that will bear out to be correct."
Whitney, a Brown graduate who worked at Oppenheimer & Co. (OPY) before setting out on her own, is not the first to warn of trouble in the muni market. Richard Ravitch, then New York's lieutenant governor, cautioned about "cracks in the municipal-bond market" in 2009. Yet Whitney, who was a contributor on Fox News Network (NWS) from 2003 to 2007, has become a media luminary, and her views generate a lot of attention.
On Sept. 28, Meredith Whitney Advisory Group, the New York firm she started after correctly predicting Citigroup's 2008 dividend cut, produced a report for clients called "Tragedy of the Commons." The report does not say anything about sizable defaults amounting to hundreds of billions of dollars. Nor does a long addendum that profiles 15 states, according to a person who has seen it. Asked why not, Whitney says: "There are fifth-derivative dimensions that I don't think I need to spell out to my clients."
On page 2, the report says, "While we do not believe defaults on debt at the state level pose a significant risk, we believe there will invariably be defaults at the local level," and does not elaborate. Whitney's thesis is that struggling states will cut aid to local governments. The report adds that "states will default in a different way. We believe states have and will continue to default on social contracts in the form of reduced spending" on programs, including education and transportation.
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