Anyone remember Meredith Whitney[1] on 60 Minutes last month? She didn't cause the municipal bond not-quite-a-panic, but she became the public face of it. "There's not a doubt in my mind that you will see a spate of municipal bond defaults. You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars worth of defaults."
CNBC, not to be outdone, had Jim and Alexandra Lebenthal[2] on WSJR With Maria Bartiromo on January 21, 2011 to talk about some of Ms. Whitney's statements and the bond markets in general. I've included some excerpts here, but watch the whole thing some time. It's instructive.
Please note that I've only summarized the questions. Any answer in quotes is as accurate a transcription as possible.
Q: Could 50 - 100 jurisdictions go broke as Meredith Whitney predicts?
Alexandra: "We [municipal bond experts] just can't figure out where that number is coming from. Now let's put that in perspective for a moment. If you look back at the number of defaults from 1970 to 2009, there were four cities and states that declared bankruptcy. And clearly we had some very significant recessions over that time. Not as great as now. And even if you look at the number of total bankruptcies in municipals which includes revenue bonds backed by a specific project, that number goes up to about 54. By comparison you had 1700 corporate defaults. So the numbers don't make sense."
Q: What do investors in muni bonds need to understand about the chance of a default?
Jim: "Let me put it in perspective. We're talking about a security that has a payment record second in safety only to the United States government itself. We're talking about bonds that are paid from the first dollar in the city's treasury - not the last - or, in the case of revenue bonds, that are backed by the power of the authority to charge for a necessity of life. We're talking about communities - state and local governments - that exist in perpetuity. We're talking about projects, necessities of life, that the community can't live without. So we're talking about something that is so essential to the ongoing well-being of the nation that to be talking about massive defaults is the equivalent of talking about the meteors, the downfall of Rome, and the end of Western civilization."
Q: So what happens when there isn't enough money?
Jim: "Services get cut. Services are the first things to go. The bonds are the last things to go."
Alexandra: "If you look at the statistics, on average debt represents about 4% to 5% of a municipality's budget. So it is not a major item."
Jim and Alexandra also made some common sense recommendations about what can be done to minimize risk when buying municipal bonds:
- Look at AA and AAA rated bonds. That will help you avoid risk.
- Look at ETFs and mutual funds to diversify risk.
- Look for bonds that are for an essential public service - sewers, school districts, roads, and so on.
So, are Jim and Alexandra Lebenthal right, and Meredith Whitney wrong? It's - obviously - impossible to say right now. But it's probably safe to say that the two municipal bond analysts and traders understand the municipal bond situation better than an equity analyst and trader.
[1] Who is Meredith Whitney, and why do we care what she says? According to Wikipedia, she manages Meredith Whitney Advisory Group, LLC., which produces company-specific equity research on financial institutions and analyzes the sector's operating environment. She first caught attention for here extremely bearish (but accurate) report on Citigroup back in October 2007. Forbes.com listed her as the second best stock picker in the capital markets industry in 2007.
[2] Again, who? And why do we care? They are the owners and operators of Lebenthal & Co, LLC. Amongst other things, they are municipal bond analysts and traders.
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