Meredith Does the Moonwalk

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

In the 1980s, Michael Jackson caused a sensation performing a dance technique called the moonwalk, or backslide, in which he appears to be pulled backward while attempting to walk forward.

That image comes to mind today as banking analyst Meredith Whitney elaborates further on municipal finance.

Muni experts underwhelmed

Since her now-famous prediction of widespread muni bond defaults was broadcast on “60 Minutes” last December, numerous government and industry leaders weighed in, and the overwhelming majority found her forecast lacking, to say the least.

California Treasurer Bill Lockyer called it “apocalyptic arm-waving,” according to Bloomberg. “A stunning lack of understanding of the municipal sector….” opined Christopher Hoene, of the National League of Cities. Whitney’s research “wasn’t worth the paper it was written on,” according to a PIMCO representative cited by FOX Business. Bill Gross, the “bond king,” said simply that he doesn’t “subscribe to the theory” Whitney espouses.

Her controversial remarks spawned a chorus of media reports scrutinizing her analysis, and revealed, among other things, a startling contradiction between her public comments and the report she cites, which her firm, according to Whitney, spent two years and thousands of man hours compiling.  In addition, she appears to be backing off her more inflammatory comments in a way that bears a striking resemblance to the dance move Jackson made famous.

Public comments vs. private report

For example, in the “60 Minutes” interview, Whitney predicted “50 to 100 sizable defaults,” that “will amount to hundreds of billions of dollars worth of defaults.” Her written report, however, painted a different picture, according to Bloomberg.

Nowhere does it mention defaults amounting to “hundreds of billions of dollars”; in fact, it is considerably more circumspect: “We are not calling for any specific defaults within the scope of this report,” according to Bloomberg.

And those numbers she cites?

“It was a matter of speech,” she told Bloomberg recently. “I said 50 to 100 or more.” And anyway, as she said in a separate interview with CNBC, hundreds of billions in defaults is “not that much” in a $2.8 trillion muni bond market.

“A lot of this is, You know it, but can you prove it?” Whitney told Bloomberg. “There are fifth-derivative dimensions that I don’t think I need to spell out to my clients.”

If that’s not confusing enough, her thoughts on defaults are even more confounding.

To us, a default occurs when a borrower fails to make a payment due on a bond. On the other hand, a “technical default” indicates that the borrower has failed to meet a condition of the bond agreement, which in many cases has no effect on interest payments to the investors.

Say what?

“When I say default, I also mean not the technical definition of default,” Bloomberg quotes her in a Dec. 21 interview on her predictions. But again, her public pronouncements don’t seem to square with her written analysis.

“Debt service at the state level is not something we believe is at risk,” Bloomberg quotes the report, and it adds “states have and will continue to default on social contracts in the form of reduced spending” on services such as education and transportation. Social contracts?

She told Bloomberg that “a restructuring certainly counts as a default.”

This is clearly not the case for investors who receive their regular interest payments.

Other inflammatory remarks

Whitney has made other inflammatory remarks, most notably that defaults would spark “panic in the muni markets” and the fallout would cause “social unrest.” Under normal circumstances, those comments would probably be ignored.

But her publicity blitz (her firm reportedly charges $100,000 a year for its research) came at a time when technical factors were at work in the market, which we first discussed last November in “So-called Stampede Yields Opportunity in Muni Market“, and spooked investors were dumping shares of municipal-bond mutual funds.

As we previously mentioned, there remains no credible evidence supporting her predictions. The facts remain that investment-grade municipal bonds rarely default. Analyses by the rating agencies, whose calls in the municipal market – their traditional area of expertise – have been overwhelmingly accurate for decades, run counter to her apocalyptic vision. And recent reports indicate state revenues are increasing. In fact, muni investors are profiting from the fear mongering.

“I think folks that are saying I’m wrong are making a bigger call than I am,” Whitney told Bloomberg, while blithely dismissing her critics as “municipal-bond brokers” who would be hurt by a market meltdown.

On top of everything else, she misunderstands the function of a broker. Brokers make money when investors buy or sell. What’s in peril, however, is the livelihood of analysts who make headlines based on unsupportable evidence.

Even a fancy dance can’t save those people.

James A. Klotz is the President of FMSbonds, Inc.
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Feb 3, 2011

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