Famous fear-generator Meredith Whitney is once again generating fear about a coming fiery apocalypse for state and local governments. Fortunately, she is just as wrong about this as she always is.
That is not to say that Detroit filing for bankruptcy is a welcome sign for other municipal borrowers. It's not! Detroit is a big borrower, and it is bankrupt, and that is bad. But Whitney, as she has done ever since she became a famous analyst, takes this several steps further in an op-ed piece in the Financial Times on Tuesday, arguing that Detroit's bankruptcy is just the first in that wave of municipal defaults she has been unsuccessfully warning about for nearly three years.
"The aftershocks of the largest municipal bankruptcy in US history will be staggering, and Detroit will set important precedents," she writes.
Whitney's warnings are not always wrong: She first became famous by correctly predicting, just ahead of the financial crisis, that Citigroup was in trouble. And she is right when she points out that many municipalities are struggling to balance their obligations to current and former employees, bondholders and public services and that something will have to give.
Where she goes astray is when she says that Detroit will inspire other cities to just file for bankruptcy in order to take care of their unfunded pensions and other future liabilities.
"Detroit’s decision last week paves the way for other elected or non-elected officials to make decisions to save their cities and towns, decisions that probably involve politically unpopular actions that may secure their long-term viability," she writes.
Sounds scary, but Whitney's column is wrong in several very specific ways. For one thing, not all municipalities can file for bankruptcy protection, even if they wanted to. Many state laws prohibit bankruptcies by other muni borrowers.
And a borrower must be insolvent in order to be eligible for Chapter 9 bankruptcy. It can't just be trying to avoid future money problems, as Whitney suggests munis will do. Munis also have other options for dealing with their pension and problems besides filing for bankruptcy.
There is still some doubt that Detroit is even eligible for Chapter 9 bankruptcy, and it will take a federal judge 90 days to sort out the objections of Detroit's creditors.
More broadly, muni finances are slowly improving. The economy is getting better, however sluggishly, raising state and local tax revenues. Contra Whitney's claims about how all of our states and cities are becoming charred hellscapes just like Detroit, U.S. crime is broadly on the decline, and home prices are on the rise (though, sure, they may just be getting reinflated in a new bubble).
Three years ago, a similar warning from Whitney sparked panic in the market for municipal bonds. Back in September 2010, Whitney's research firm released a 600-page report warning of a spate of municipal defaults. Then in December 2010, she doubled down, telling "60 Minutes" that she expected "50 to 100 sizable defaults, more," adding, “This will amount to hundreds of billions of dollars’ worth of defaults.”
The muni-bond market freaked out for a while about that, wiping out a year's worth of investor returns in about two months.
But then, lo and behold, the Munipocalypse did not come to pass. The bond market recovered, while Whitney's reputation did the opposite thing. She did not help herself by trying to muddy the waters about her prediction, claiming she hadn't meant to make specific calls and was just speaking generally about the problems of muni finances. At the same time, she has refused to totally back away from her predictions, repeatedly saying she will be right eventually about whatever it was she predicted exactly. Tuesday's op-ed is the latest example.
But we have heard this tale of terror one time too many. Unlike the first time Whitney tried to scare us about munis, the bond market is not having a panic attack today. Nor should it.
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