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Whitney Defends Municipal Bond Default Prediction, As Bonds Show Signs Of Recovery

Whitney Municipal Default

The Huffington Post   First Posted: 05/05/11 01:19 PM ET Updated: 07/05/11 06:12 AM ET

Even as the municipal bond market shows signs of recovery, analyst Meredith Whitney stood by her controversial prediction of widespread defaults.

Speaking at the Milken Global Conference in Los Angeles, Whitney reiterated her belief that local governments will default on a combined "hundreds of billions of dollars' worth" of debt," Bloomberg News reports. The forecast comes as state and local bonds are recovering to levels not seen since last fall, the Wall Street Journal reports.

In late September, Whitney released a report to clients that has since hung like a specter over the municipal bond market. Her argument now is the same as it was then: States are dealing with budget woes, prompting them to cut off aid to municipalities. So, Whitney said, governments will prioritize local taxpayers over investors and choose to default on their debt.

In the months since she first made this prediction, she has taken heavy criticism from analysts and pundits, and she was the subject of a Bloomberg News piece that noted the report was thin on specifics. But in a seeming show of Whitney's influence, investors have fled municipal bonds.

As the nation recovers from the sharpest downturn since the Great Depression, cities across the nation are struggling with often crippling deficits. Tax receipts have fallen as property values have tanked and payrolls have shrunk, prompting many local governments to slash basic services at a time when residents badly need them.

Local governments have laid off teachers and crossing guards. Others have delayed repairs to broken streets and crumbling buildings. Some of the nation's statistically most dangerous cities have laid off significant portions of their police forces.

As governments have imposed these cuts, it's been the residents and the public workers who have felt the most pain -- not the investors who hold the government's debt. When a city misses a payment to its secured creditors, the cost of borrowing goes up, making it more expensive for the government to issue bonds in the future.

In 2010, the Standard & Poor's/Investortools Municipal Bond Index, which includes $1.27 trillion of municipal debt outstanding, logged just $2.65 billion in bond defaults, according to a January report from Standard & Poor's. That marked an 8.6 percent decline from 2009.

But Whitney, who famously predicted Citigroup's dividend cut in 2007, defended her position that municipal defaults would exceed $100 billion.

"I have more conviction on this than I’ve had on any single thing in my career," Whitney, who runs Meredith Whitney Advisory Group, said at the conference on Wednesday.

In recent weeks, though, the municipal bond market has appeared to be on the mend. Yields on highly rated 10-year general obligation bonds have fallen by nearly half a percentage point since the start of the year, the Wall Street Journal reports. This trend is driven partially by a smaller supply, as governments restrict issuance, the WSJ notes.

When bond yields fall and prices rise, it's a sign that investors perceive the debt as less risky. The prices to insure the debts of low-rated California and Illinois against default have fallen to their November levels, the WSJ says. Even while investors continue to withdraw money from municipal bond funds, some of the tension of the last few months appears to be easing.

As for criticism of her prediction, Whitney said she's "numb to it."

WATCH Whitney speak at the Milken conference, on Bloomberg TV:

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