Thanks, Meredith

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

What have we learned from Meredith Whitney?

It’s been a little more than two years since her infamous predictions of massive muni defaults helped send the market into a tailspin.

As it turned out, the turmoil was short lived. Investors who stayed the course, held their positions and continued to buy bonds as their investment dollars became available were well rewarded for their buy-and-hold strategy.

In fact, as we pointed out back then (“Profit from the Fear Mongering“, “Wall Street Journal Message Resonates in Unlikely Places”) there was no crisis and the turnaround was expected – at least by cooler heads – though rational analyses were drowned out by the cries of doomsayers.

Fanning the flames

“I expect multiple municipal defaults to trigger indiscriminate selling, which will prompt a federal response,” Whitney wrote in a Nov. 3, 2010, Wall Street Journal op-ed piece.

The selling did happen, of course. But investors who heeded her forecast sacrificed billions of dollars when prices rebounded. The defaults never happened, the federal government never got involved—in fact, prices soared as yields on municipal bonds tumbled to historic lows.

In her “60 Minutes” interview in late 2010, she foresaw 50 to 100 municipal defaults, amounting to “hundreds of billions” in principal, another call, of course, that was wildly off the mark.

The few municipal bond defaults that have occurred since late 2010 include high-profile cases like Jefferson County, Ala.; Harrisburg, Pa.; and San Bernardino and Stockton, Calif., whose financial problems were well-known long before Whitney’s prediction. Others were small, like Mammoth Lakes, Calif., where the final adjudication of a $42 million damage award pushed a town with just $4 million in total debt into bankruptcy.

Defaults in the $3.7 trillion muni market were, as they always have been, infinitesimal.

The takeaway

Notwithstanding her dismal record as a muni market prognosticator, Whitney’s calls do serve as a potent reminder of important principles.

Municipal finances tend to evolve in slow motion and lag economic activity; states, cities and towns can almost invariably avoid default through a combination of timely tax increases and spending cuts. Reluctant politicians prefer to implement unpopular policies than incur the permanent increase in financing costs a default would entail. A good example is California (see: California’s Finances Riding a Wave).

Today, we are “back to boring,” with state and local governments getting healthier, economic activity on the rise and fiscal responsibility among political leaders in vogue. We’ve moved on from the thrills and chills that were once dominating the headlines.

Whitney, too, has apparently evolved.

Though inaccurate, her apocalyptic visions played well in the media and she landed a book deal. Originally titled, “Downgraded: Why the Next Economic Crisis Will be Local,” the book was slated for publication in November 2012.

Now, according to the publisher, the title is, “Fate of the States: The New Geography of American Prosperity,” scheduled out in June 2013. It’s about “how we’re moving into a new era in which wealth, power, and opportunity flow away from the coasts toward the interior of the country.”

Though she doesn’t seem to be talking about widespread defaults anymore, the book may still generate some discourse, as she’s bound to take a swipe at municipal finances even if downgrades and defaults are no longer the main event.

Trust the fundamentals

Success in the muni market has never been about hyperbole; it’s much simpler: Buy good quality bonds at the best yields when investment funds are available. Don’t attempt to time the market. Those who sold on the 2010-era hysteria won’t soon forget they abandoned high-quality munis yielding 5.50%.

James A. Klotz is the President of FMSbonds, Inc.
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Mar 25, 2013

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