To readers of the business press, the story is a familiar one: fifteen months ago, superstar analyst Meredith Whitney rocked the world of municipal finance with a December 2010 prediction on 60 Minutes that a wave of municipal debt defaults was headed our way. Her forecast was quite specific: "You could see fifty to a hundred sizable defaults," she told her interviewer, correspondent Steve Kroft. "This will amount to hundreds of billions of dollars' worth of defaults."
The bottom fell out of the muni bond market as a result. Investors pulled some $14 billion from muni bond funds between December 22 and February 2, 2011, and returns in the fourth quarter of 2010 were the lowest in 16 years. Long-time players in the space, including analysts, fund managers, and muni brokers, reacted with indignation that an arriviste such as Whitney—the woman who made her name calling out Citigroup (C) as an emperor with no clothes at the dawn of the mortgage crisis—dared to try to expand her analytical purview into their cozy little corner of the capital markets.
She was wrong, they said. She didn't know squat about how their market worked. The kind of defaults she called for were never going to happen. And they were right, in the most literal sense. Since then, there have only been $2.6 billion in defaults from the $3.7 trillion market. And the muni bond swoon didn't even last very long: in 2011, Barclay's muni bond index returned 10.7%, more than five times the 2.1% return of the S&P500.
Nothing satisfies like a comedown of a prominent prognosticator, and Whitney has taken her lumps in both the business press and the more unbridled blogosphere ever since. She deserves at least some of it, but that's only for being overly specific. The more general point that she was trying to make—that municipal finances in this country were a mess that was only going to get messier—was dead on. Laugh at her all you want, but then try this: go find one person who says their local taxes are falling or their municipal services have improved in the past year or two. I wish you luck in your endeavor.
"States have pushed more and more expenses down to the local level," Whitney tells Fortune. "And municipalities don't have the money to make up the difference. That is where you see the real strain, especially after the American Reinvestment Recovery Act expired in June 2011."
Whitney's September 2010 report on municipal finances didn't contain a single call on a specific municipal bond. Indeed, the 1,400-page beast of analysis, titled "The Tragedy of the Commons," was instead focused on delineating the myriad—and slightly terrifying—financial obligations that the largest states in the country were having increasing trouble meeting. Something had to change, she said. And something did. It just wasn't as simple as a bunch of outright defaults.
When the criticism came raining down on her in early 2011, Whitney explained that she didn't just mean "technical" bond defaults but also mushier terms such a "social contract defaults"—e.g. less frequent trash removal schedules—and "employment contract defaults"—e.g. government employees being forced to contribute to their own pensions. Whether you think she tried to change the conversation after the fact or was merely elaborating is really neither here nor there. Because all of that is happening, and more. Municipal bond brokers may still find the time to chuckle about Whitney's comeuppance, but if you're someone responsible for actually dealing with the real-life implications of deteriorating muni finances, the mirth becomes a little harder to come by.
