Muniland needs defenders when Meredith Whitney talks her book
Yesterday DealBook announced the dreariest news possible for muniland: Meredith Whitney is publishing a book entitled Downgraded: Why the Next Economic Crisis Will Be Local, which is due out in November. DealBook says:
In the book, Ms. Whitney — who shook [municipal] bond markets with a 2010 appearance on “60 Minutes” in which she predicted scores of municipal defaults –will “reveal why America’s cities and states are in deeper trouble than is commonly realized,” according to the publisher.
The truth is that when Whitney made her infamous muniland prediction, she spooked retail investors into fleeing the municipal bond market in droves. These investors suffered tens of billions of dollars in losses, thanks to her.
The biggest problem at the time of Whitney’s call was that no muniland market professionals stepped up to refute her “opinions.” There are several reasons for the lack of push back: Muniland professionals thought her call was so outlandish no one would believe it; the media didn’t have a deep bench of municipal bond professionals to call upon to refute her; and by tradition and compliance rules, most municipal bond professionals are hesitant to speak in public. So Whitney had the stage pretty much to herself to knock down the municipal bond market.
Now Whitney is altering her story. Whereas she previously proclaimed that weak fiscal conditions will cause hundreds of billions of dollars in municipal bond defaults, she now says only that horrific fiscal conditions are hidden away from public view. The truth is that practically every state and local entity is down in the trenches fighting the hard battles to right its fiscal position. Day after day local and national media are full of stories of program cuts, shrinking numbers of government employees, pension reforms and very low municipal bond issuance. For example Illinois, the nation’s weakest state fiscally speaking, commences its budget battle today with the governor releasing his proposal for the coming fiscal year. From the Illinois Statehouse News:
Illinois’ local governments, parks, prisons and police officers are going to have to fight over the leftovers of Gov. Pat Quinn’s budget proposal.
“There is no new money for anything,” said Quinn’s Budget Director David Vaught on Tuesday night. “Everything but Medicaid and pensions will be squeezed.”
Munis are the star performer of 2011
Bloomberg had a great piece that rounds up the factors that made municipal bonds the best performing financial asset of the past year. The story is framed as a knock on Meredith Whitney for her scare call a year ago:
This was supposed to be the year the $3.7 trillion state and local debt market would be rocked by an exploding pension time bomb and “hundreds of billions of dollars” of defaults, according to analyst Meredith Whitney.
Whitney’s Armageddon never came. Instead, munis became the star performers of 2011.
An investor who bought $10,000 of munis the day after Whitney’s Dec. 19 prediction on CBS’s “60 Minutes” television program would have made about $1,050, based on the 10.5 percent gain in the Merrill Lynch Municipal Master Index, which calculates price changes and interest income. That beats U.S. Treasuries, stocks, corporate bonds and commodities. The muni return is better still because interest income is tax-exempt.
[...]
When returns are adjusted for price volatility, municipal bonds returned about three times more than corporate bonds and twice as much as Treasuries, according to Bank of America Merrill Lynch and Bloomberg data.
More Whitney rebuttals
The media is full of municipal bond market participants rehashing Meredith Whitney’s prediction of muni collapse which began last September. From Bloomberg:
[Meredith] Whitney, the banking analyst who predicted Citigroup Inc.’s 2008 dividend cut, said on “60 Minutes” on Dec. 19, 2010 that there would be “hundreds of billions of dollars” of municipal defaults within 12 months.
Data from [John Hallacy, Bank of America Merrill Lynch’s head of municipal research in New York], Standard & Poor’s and Municipal Market Advisors show the opposite.
Debt-service payment defaults this year are the equivalent of 0.64 percent of municipal-bond sales, compared with 0.99 percent for 2010, Hallacy wrote in a report last week. About 99 percent of the defaults have been revenue bonds. Health-care accounted for the biggest chunk, at 39 percent. Hallacy included monetary defaults or missed payments to investors in his tally.
The largest default for 2011 is the Clare at Water Tower, a 53-story apartment building for retirees in Chicago with about $229 million of long-term debt, according to Richard Lehmann, publisher of the Distressed Debt Securities Newsletter in Miami Lakes, Florida.
Where federal cuts to state aid will likely come from
State officials have banded together to try and influence federal budget cuts that affect states. From Reuters:
State officials appear most unified on an alternative cost-cutting strategy, which they say could save more than $100 billion by changing the healthcare delivery system for the poorest, sickest and most costly patients. Known as “dual-eligibles,” they qualify for both Medicaid and Medicare, the government-run program for the elderly.
There are about 9 million dual-eligibles and state officials see billions of dollars in savings from shifting them into managed care plans better able to eliminate unnecessary doctor’s visits, tests and hospital admissions.
“Support for that proposition is very broad,” Maryland Governor Martin O’Malley, who chairs the Democratic Governors Association, told Reuters.
States also hope the super committee will adopt proposals to control Medicaid prescription drug costs, combat waste and fraud, and relax federal restrictions on benefits and eligibility, lobbyists said.
@Twitter Talk
Ha ha, more like ‘Meredith re-bashing’ as she has certainly been proven to be around some kind of bend.
Keep in mind Chou Enlai was asked what he thought about the French Revolution; “Too soon to tell …”
Meanwhile, the munis default but by firing staff, which shifts the liability from issuers directly toward countercyclicals: unemployment insurance, SS and pensions … from the muni sector to the Federal sector.
Meredith Whitney’s anniversary
Two big events happened on Tuesday in the municipal bond market: it was the annual conference of SIFMA, one of the industry trade associations; and it was also the one-year anniversary when Meredith Whitney began her campaign of predicting the collapse of the muni market. Whitney was of course way off-base with her prediction of hundreds of billions of dollars in bond defaults. In fact less than $1 billion of muni bonds have defaulted so far . But many believe that she did cause substantial damage to retail investors, mutual funds and insurance companies, all of whom were caught up in the downdraft of selling that followed her words of doom.
The reason that her words were so damaging to muniland was that there is little natural elasticity in the ebb and flow of the market structure — or, in market jargon, there is little liquidity. When large sell-offs happen in the equity or U.S. Treasury markets there is always a ready pool of buyers standing ready to pick up those securities at lower levels. These markets are favorites for traders and fast money because they encounter little friction, meaning the price rarely moves against them when entering and exiting the market. In contrast, there are few pools of buyers that understand the muni market and are able to do quick credit analysis of bonds for sale, not to mention the lack of shared pricing data that would let participants see if they are transacting at updated, fair-market prices. Because muniland is not really liquid, when Whitney yelled “fire” there was no orderly way for the crowd to exit the theater.
There are structural reasons why little liquidity exists in muni markets. For example, over 50,000 local and state governments have issued over 700,000 different municipal securities. On a given day only about 15,000 of these individual securities change hands in about 40,000 trades. The Municipal Securities Rulemaking Board stated in their annual fact book that about 10 million muni bond trades happened for the year 2010. In contrast, the New York Stock Exchange had 95 million trades in month of December 2010 alone.
For individual muni bonds there is generally not a daily pattern of buying and selling that would easily help establish a price. Markets instead look at similar bonds that have recently traded and try to extrapolate a current price. When the massive waves of selling happened around Whitney’s market call, the natural process of price discovery was disrupted and dealers didn’t want to take bonds into inventory as markets moved lower day after day.
Whitney’s call for muni apocalpyse scared many retail investors who promptly sold their muni bond funds and fled out the exit door. This mutual-fund selling caused fund-management groups to quickly sell bonds out of their portfolios. Unfortunately there were few buyers waiting to absorb these sales. Whitney’s call created a velocity of supply that hadn’t been seen in muni markets since the general market panic of 2008. Buyers stepped in eventually of course, but it was primarily high net worth individuals and hedge funds who had years of experience with the asset class and believed that the bonds continued to be rock-solid.
Regulator wants to require “fair dealing”
Regulator wants to require fair dealing
In a far-reaching proposal, the Municipal Securities Rulemaking Board (MSRB) has asked the Securities and Exchange Commission for permission to impose new rules to protect municipalities. These rules would vastly expand the disclosures that dealer underwriters are required to give their municipal clients who issue bonds.
MSRB’s executive director Lynnette Kelly Hotchkiss said in a statement:
Dodd-Frank explicitly requires the MSRB to protect municipal entities. This gives us the ability to establish detailed requirements for underwriters and make important information more readily available to state and local governments that sell bonds.
The rules would require disclosure of “conflicts of interest” to municipalities before they enter into contracts to issue bonds. Specifically the new rules would require banks to:
- disclose all “material risks” associated with bond financings
- disclose when floating-rate securities are coupled with interest-rate swaps
- disclose potential conflicts of interest
- disclose incentives paid to recommend transactions
- disclose payments they may get from other parties in a deal
- disclose if they have derivative contracts that only pay off if the borrower defaults
The blog Dodd-Frank.com points out the simple effect of the proposed rules:
Is Meredith Whitney a ratings’ driver for CNBC?
It’s more than a little frustrating that CNBC continues to feature equity analyst Meredith Whitney as she talks about municipal bonds over and over again. I’m not really sure she evens knows what she is talking about.
Matt Fabian, managing director at Municipal Market Advisors, shined on this same topic in this interview with Tom Keene on Bloomberg Television in May. Matt Fabian of MMA or Daniel Berger of Thomson Reuters Municipal Market Data would both be far superior in terms of talking accurately about muniland. Both have analyzed muni bonds for over a decade and can talk about the unique conditions each issuer is facing. Neither of them work for a sell-side firm, so they would not be arguing for issuers that they favor or that their firms hold inventory in.
Here is what the National League of Cities said in May about Ms Whitney (emphasis mine):
“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 … have been calling attention to state-local fiscal pressures requiring layoffs and service cuts, and the potential drag on the economic recovery.
“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.
“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.
“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.
One of the real and substantial implications occurred last November when Ms. Whitney spoke on “60 Minutes” and the muni markets sold off. This caused losses to investors and raised borrowing costs for muni issuers.
Kate Marshall, the State Treasurer of Nevada, had even more pointed criticism of Ms. Whitney. CNBC itself reports:
I think the simple answer to your question is that they believe she may have a point or at least they want to get people talking about the issue and expressing opinions. I don’t think they have been one sided in their presentations. As for the issues, even if we close our eyes and stick our heads in the sand, the problems will not pass. Much of the pension liabilities are now turning into cash outflows as baby boomers are retiring in large numbers so if we are at this percent or that percent, not sure if it would matter.
Save the $100,000 that Meredith Whitney charges for research
Just the numbers please
You can save the $100,000 that Meredith Whitney charges for her research. Reuters has the data on municipal bond issuers with the weakest profiles by bond-market standards. Puerto Rico leads the pack as the least credit-worthy issuer.
The roots of delusion
Small snippet from an excellent piece in the New York Times on the roots of the unfunded pension mess (emphasis mine):
It was 1999, and the California Public Employees’ Retirement System, or Calpers, the large government agency that manages retirement benefits for more than 1.6 million public workers, retirees and their families, was lobbying the legislature to increase employees’ benefits. Calpers’s plan would lower the retirement age for some workers to 50 years, even as it raised pensions to as much as 90 percent of their salaries.
Lobbyists were arguing that the plan — which would ultimately create the largest pension increase in the state’s history — wouldn’t cost “a dime of additional taxpayer money.”
But Mr. Seeling, the agency’s chief actuary, knew that wasn’t necessarily right. Sitting at his desk, poring over spreadsheets, he saw the truth. Calpers, at the time, was awash in cash and many cities believed that pensions were essentially self-funding if the stock market remained high. But if the market stumbled, he realized, Calpers’s plan could cost taxpayers billions of dollars.
Round three for California
California passed a budget last week, but then State Comptroller Chiang said it was not balanced and Governor Brown vetoed it. Now the Governor will bring a new budget proposal forward. Is Hollywood writing this script?
Flight three of muniland’s harpy
I had really hoped that Meredith Whitney had gone back to analyzing banks and trying to interpret how the new Basel 3 liquidity ratio would be phased in. Unfortunately, she is back touring the mainstream financial media with another shrill message for muniland.
Muniland’s loudest harpy threw out some real doozies yesterday on CNBC and in a Fortune interview. The most outlandish claims Ms. Whitney made related to the proportion of state’s budgets that were going to service their debts. The substance of her statements were expertly demolished by Nicholas Johnson of the Center on Budget and Policy Priorities:
Whitney wildly exaggerates what states are spending on interest, claiming for instance that “debt service absorbs half of Nevada’s budget.”
Actually, Nevada’s own audited financial report shows that debt service (principal plus interest) is about 4.1 percent of state spending. Nor is it true that “Fixed interest expenses are absorbing a bigger and bigger share of state budgets”; interest payments have been declining as a share of state and local spending since the mid-1980s, as my colleague Iris J. Lav told Congress earlier this year.
Another big doozy from Ms. Whitney relates to pension funding. Here’s Nicholas Johnson again:
Whitney accuses states of “systematically underfunding their pensions” but then contradicts herself by noting that pensions were fully funded before they took a double-hit from the last two recessions. She also asserts that if states were to fund fully their pension promises, it would cost them 40 percent of their budgets.
That’s light-years from the truth. Boston College’s Center for Retirement Research says that states and localities can fund their pension promises fully if they devote somewhere between 5 and 9 percent of their budgets to employee retirement funds, because they do not have to close their current funding gaps all at once but rather can do so over time. If states make appropriate reforms to their pension systems, the cost can be even less.
There is a pile of work rebutting Ms Whitney. Much of it is distributed privately, the preferred method for the fixed-income world, but more and more of muniland pros are coming out to rebut her statements publicly. This is good because Ms Whitney has been sucking up all the oxygen in the room.
Muni sweeps: Lockyer rides again
CA Treasurer launches another derivatives investigation
We often see Wall Street selling sophisticated products to state and local governments which are not appropriate for them — think interest rate swaps and Jefferson County. So it’s always refreshing to find a government official who actually tries to keep Wall Street in line.
Sharp-eyed California State Treasurer Bill Lockyer has been monitoring the spread (price) levels for the state’s credit-default swaps. He noticed a very significant one-day drop in CMA Datavision (one of two muni CDS price aggregators) and wants to understand what caused this. Katy Burne at Dow Jones has done an excellent job reporting the story:
California’s state treasurer is looking into what he believes were erroneous prices reported last month for credit-default swaps tied to the state’s debt.
The annual cost of protecting $10 million of California debt against default over the next five years fell by $45,000 from one day to the next last month, an extraordinarily big overnight move. Tom Dresslar, a spokesman for Treasurer Bill Lockyer, said that CMA DataVision provided the prices to Bloomberg’s fixed-income data service.
Lockyer suspects the cost of credit-default swaps, which are expressed as a percentage of the amount of debt covered, was artificially high before the adjustment.
“To the extent our prices are wrong, particularly if they are on the high side, that presents an inaccurate picture of our creditworthiness, at least in some corners,” said Dresslar in an interview Tuesday.
The chart above is from the other muni CDS price aggregator, Markit, and they did not report an inverted yield curve.
This is not the first time that Treasurer Lockyer has made a point of investigating the swaps on his state’s debt. In an April 28 Muniland post I wrote about how Lockyer queried Wall Street firms on the amount of their California CDS:
Muni sweeps: How does $775 billion of bonds go missing?
How does $775 billion of bonds go missing?
There is a sleeper story in muniland about a big pile of just-discovered municipal bonds. The story has some odd twists and turns. John McDermott of FT Alphaville scooped the details yesterday:
FT Alphaville typically estimates the size of the muni market at $2,900bn, based on year-end 2010 data from the Federal Reserve. The FT uses the same figure, occasionally rounding up to $3,000bn.
But the Fed is underestimating the size of the market by nearly $800bn, according to analysis by Citigroup’s municipal bond team.
You can’t “undercount” $775 billion of municipal bonds unless your data systems are seriously messed up. And whose system is seriously messed up? According to Citigroup’s George Friedlander, it’s the Federal Reserve. After a recent meeting and discussion with the Fed, Mr. Friedlander has announced a substantial jump in the size of muniland. FT Alphaville has this excerpt from Friedlander’s report:
After considerable conversation with Federal Reserve staff and recalculation based upon separate sources, we have concluded that the Fed’s data dramatically understates the amount of outstanding municipals. We now estimate that there is a sum total of roughly $3.7 trillion in state and local debt outstanding, in comparison with the $2.925 trillion reported by the Fed for year-end 2010. While the Fed may modify its data at some point, we felt that it was important to present this modified picture of the size and mix of holdings on a timely basis.
Does the Fed usually announce such enormous changes in data this way? The $2.9 trillion number for the size of muniland is also the same figure used by the Securities Industry Financial Markets Association (SIFMA), the trade group for the securities and bond markets. The Bond Buyer pointed to the sourcing of data for the Fed’s error:
Cate, I wouldn’t bother your editor with this misguided correction (“I believe it’s grammatically incorrect,” to correct the comment). That rule was devised by grammarians who wanted English to behave more like Latin. Search on “preposition end sentence” for more on the subject.
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Resident Muniland expert
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