It’s tough to create buzz around securities that are about as boring as they are dependable, but that didn’t stop one pundit, whose doomsday prediction on municipal bond defaults set the market afire.

That call, now eight years old, was wildly off the mark, but it has spawned a fresh take today. In the revised view, the infamous prediction was correct – just early.

Apparently, the quest to make news in the muni market lives on.

Municipal Bond Defaults Call Debunked, Mutates

‘Sizable’ municipal bond defaults?

As many investors recall, Meredith Whitney said in a December 2010 broadcast of “60 Minutes” there would be “50 to 100 sizable defaults” in the municipal bond market during the upcoming year. The defaults would total “hundreds of billions of dollars,” she said.

A banking analyst who three years earlier accurately foresaw Citigroup’s mortgage woes, Whitney’s bold bond outlook caused a sensation among many and spooked the market.

Subsequent to the broadcast, for example, the Bloomberg Barclays Municipal Bond Total Return Index fell 2% over a month.

But we, like many others, didn’t buy the municipal bond default prediction then, nor do we subscribe to the revised version now.

Whitney’s vision, of course, never came to pass. In fact, soon after the broadcast, she began backtracking, though misperceptions from her earlier pronouncements remained.

As we outlined (“Muni Market: Heal Thyself”), the selloff in the wake of her interview was driven not by credit-quality issues but by the liquidation of muni mutual fund shares held by non-traditional buyers, who had been accumulating shares in record numbers.

This forced fund managers to sell holdings they otherwise would’ve preferred to keep.

Meantime, we saw a bargain.

Not only did traditional bond buyers stay the course, they proceeded to take advantage of higher yields and add quality bonds to their portfolios at bargain prices.

Fresh look on a bad call

Fast-forward to today, where eight years after the original municipal bond default prediction comes Doomsday Scenario 2.0, a view posited in a Wall Street Journal article.

In the author’s view, the finances of state and local governments have declined since 2010, and Whitney’s call “will be remembered as right but early.”

Can a prediction be accurate if it’s eight years off the mark? We don’t think so, but that aside, we find this updated analysis lacking as well.

The argument centers on the health of public pension plans. In short, are they as precarious as the doomsayers think?

Milliman, an actuarial firm, conducts an annual study of the funding status of the 100 largest U.S. public pension plans.

Its study last year estimated the aggregate funded ratio is almost 71%. With research suggesting 80% as a reasonable level, according to Bloomberg, the plans currently aren’t too far off.

The Journal article further states that rising interest rates and a recession may be a “tipping point” for pension plans.

Of course, history suggests that guessing the direction of interest rates – or whether they move at all – is a futile exercise.

But let’s say they do rise. Pension funds invest heavily in fixed-income securities, so increased yields would be advantageous.

Analyze muni revenue stream

The failure among soothsayers doesn’t mean there aren’t challenges in the market. There are, and they are well documented precisely because they’re so unusual. We fully recognize that all investments contain some degree of risk.

For municipal bond investors, though, nothing has changed. It’s always been important to judge the quality of munis, a relatively simple task once you understand the revenue stream used to pay investors. That’s been true since the advent of municipal bonds.

What’s genuinely risky is heeding dubious guesswork, which instead of fading, can mutate into other reckless theories.

James A. Klotz is the President of FMSbonds, Inc. Email the Author12/17/2018