9. Meredith Whitney is right about the coming municipal defaults.
The media has been doing their damnedest to discredit Meredith Whitney, who is most well known for predicting the financial meltdown. Whitney appeared on 60 Minutes late last year where she predicted that 50-100 municipal entities would go bankrupt and default on their bonds, wiping out “hundreds of billions” in investments. The savaging of Whitney by media talking heads was immediate.
Charlie Gasperino wrote a piece at the Huffington Post claiming Whitney should “show her cards,” which basically accused her of making wild accusations she couldn’t back up … ignoring the 600-page report her company has made available to customers. Dishonestly he used the fact that this report was proprietary to attack Whitney’s credibility. Bloomberg columnist Joe Mysak made an even more specious attack with an argument that defies logic:
Why would a governmental entity go out of its way to provoke or alienate its best source of finance? In the old days you might say that bondholders were a distant class of banks and plutocrats mainly centered in the Northeast. That’s no longer true, and hasn’t been since at least the passage of the Tax Reform Act of 1986, which made bonds less attractive for banks and insurance companies, among other things. Today, a city’s bondholders might live in the municipality itself, and almost certainly reside within the state.
Why would a governmental entity choose to default on its bonds, especially if they make up a relatively small proportion of its costs?
“Debt levels for U.S. local and state governments are relatively low, with annual debt service representing a relatively small part of budgets,” Fitch Ratings said in a special report in November.
Entitled “U.S. State and Local Government Bond Credit Quality: More Sparks Than Fire,” the report said, “The tax- supported debt of an average state is equal to just 3 percent – 4 percent of personal income, and local debt roughly 3 percent – 5 percent of property value. Debt service is generally less than 10 percent of a state or local government’s budget, and in many cases much less.”
The answers to these questions are simple, bond holders are the easiest people to stop paying. The majority of state and local budgets go to entitlements and pension obligations that they can’t get out of. Worse, if they do try to cut them they face Wisconsin-like push backs from special interest groups. There is no bond holder union however, and it’s unlikely that bond holders will make bomb threats against public officials, threaten local businesses and cause millions of dollars in damages to government buildings.
State and local governments will simply have no choice but to default, because they won’t be able to trim the budget in other places without risking civil unrest. Would you want to be in New York City the day the local government discontinues all bus services?
Boise County just filed for bankruptcy and they don’t have overwhelming public debt – just financial problems like hundreds of other municipalities. The expiration of the Obama administration’s Build America Bonds has led to the sharpest decline of bond issuance in recent history which will exacerbate the financial woes of states which are already suffering loss from the recession driven decline of tax revenue. Property taxes have declined along with property values, and high unemployment has not just lowered tax revenues but increased government liability. How can bonds be considered a safe investment in this environment?
The talking heads in the media are smart enough to be afraid of the consequences of a municipal bond meltdown and are desperate to try to keep people from panicking. But this is one part of the economy that is not driven by psychology. There isn’t enough money for state and local governments to continue to operate, and there’s nothing anyone can do about it unless the people within the municipalities will accept cuts to services that make Greek austerity measures seem modest. Wisconsin proves that isn’t possible, so what exactly do the talking heads think will happen?