Almost six months ago, Meredith Whitney – the controversial financial investor who made her name by predicting the recent troubles for Wall Street banks – set off a firestorm in financial markets by claiming that “social unrest” was coming in the form of ”50-100 sizeable municipal defaults.” She’s back this week with an op-ed in the Wall Street Journal where she claims the fiscal pressures on states threaten the economy.
Mostly though, the op-ed is an attempt to sell her latest 77-page report and keep her name in the category of celebrated market analysts (or is it celebrity market analysts?).
In a piece that reads more like political commentary than market analysis, Whitney claims that fiscal pressures on states threaten economic recovery. But, this is hardly news. Over the last several years, NLC, a host of state-focused groups (CBPP, NGA, NASBO, SUNY-Rockefeller), and President Obama, among others, have been calling attention to state-local fiscal pressures requiring layoffs and service cuts, and the potential drag on the economic recovery.
Whitney’s op-ed focuses, in part, on unfunded state pension liabilities – also true, though in many cases the cause is an underperforming market in recent years. While we don’t deny there is more work that needs to be done on this front, this work is already underway in state and local governments across the country.
But, fiscal pressure from cyclical revenue declines and pension liabilities does not add up to Whitney’s doomsday predictions of sizeable defaults and social unrest. The latest version of Whitney’s misinformation campaign includes her note at the end of the WSJ piece that “Municipal bond holders will experience their own form of contract renegotiation in the form of debt restructurings at the local level.” Yet, restructuring debt does not necessarily qualify as default, nor is it destabilizing to financial markets (since, in most instances, investors are kept whole).
Whitney’s op-ed is an example of the misinformation permeating the national dialogue about state and local finances. She’s in good company, as poorly constructed arguments about state-local insolvency have, in recent months, riddled airwaves and policy debates: confusion over structural deficits versus budget shortfalls, a lack of understanding of local municipal budgeting processes that place debt service payments above all else, and a near-total lack of understanding of the difference between municipalities with general obligation bonds as opposed to revenue bonds and conduit bonds.
Now Whitney seems to be suggesting that renegotiating labor contracts and restructuring debt are signs of a failing sector, when in fact, these actions occur all the time during both good and bad economic times.
Once again, Whitney’s “call” is a distraction from the real story, which is about the difficult choices local and state leaders are making about delivering services. There are real implications when the wrong information is pushed and repeated over and over in the media for ratings, report-sales, and celebrity status. Earlier this year retail investors fled the bond market over exaggerated concerns, followed by a series of poorly conceived policy proposals on state bankruptcy, federal intervention in state pensions, and public sector compensation.
All of this combines into one big pot of bad smelling soup because American taxpayers are on the hook for paying more for services like schools and infrastructure projects. When Whitney and her supporters get it wrong on the corporate side, only her clients (and her clients’ shareholders) suffer. When they get it wrong on the municipal bond side, communities and taxpayers pay the price.
Gross Exaggeration or Factually Ambiguous (or both?)
In recent media interviews, Whitney waffled on her earlier predictions. First, on Bloomberg Radio she argued that the sequence leading to a run on the muni bond market would start with widespread downgrades of municipal issuers. Exodus from the municipal market would be led by insurance companies whose portfolios are limited to holding only the highest-rated municipal securities. From there, the run is on…Scary stuff, except Standard & Poor’s just published predictions that widespread downgrades are unlikely.
Add to this the fact that there has not been any real increase in sizeable municipal bankruptcies since Whitney made her now-infamous prediction in December. Whitney’s latest backtracking on that prediction described her overreach as an “approximation for the current cycle”. Huh? In other words, it was a gross exaggeration (she also had a report to sell at the time) or factually ambiguous, or both.
At the same time this week, new reports show that revenue at the state level is up. Concern over the finances of local governments started more than two years ago. While localities still have a couple of tough years ahead of them, our own research (forthcoming) shows that local economic indicators are improving.
In the end, it’s useful to remember that cities and other local governments must balance their budgets. For most, it’s required by state law and few cities could function if they did not balance their budgets every year. Cities also have the ability to raise taxes. Unlike a company that is facing economic hardship, cities can compel revenue. While this may not be politically popular, it insures fiscal solvency in the municipal sector.
The real story, hidden by misinformation provided by Whitney and others, continues to be about the services that are being cut and the implications of those service cuts for communities. That’s the real risk. Cities will survive, but we will see continued cuts to necessary services like schools, fire and police. And the evidence shows city leaders will cut the services rather than destroy city credit ratings. Investors should worry less about the risk of systematic collapse of the bond market and instead worry more about whether their local school, police department, or fire hall down the street needs a fundraiser to stay in service?