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Meredith Whitney's Bad Prediction

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Wall Street analysts make bad calls all the time, but among the worst made at least in recent history has to be Meredith Whitney's prediction back in 2010 that the municipal-bond market was set for an epic implosion.

What makes Whitney's call so bad isn't necessarily that in the nearly three years since she rang the alarm bells of the imminent demise of municipal bond market, she has been proven so terribly wrong.

Like I said, analysts (and journalists) screw up all the time.

Whitney's sin is that she isn't intellectually honest enough simply to say she screwed up. Instead she and her defenders offer up absurd explanations to defend an indefensible market call that caused average investors to lose lots of money even if it got Whitney a book deal in the process.

All of which is good reason to ignore her new book on how the so-called fly-over country of the Midwest with is fiscal conservatism and low taxes is crushing the coasts in terms of prosperity. I haven't read the book; nor do I plan to and not just because of this review from my old boss Joe Mysak, who picks it apart, nearly line by line.

The reason I'll be staying clear is because I just can't trust much of what Whitney says these days. The same analyst who boldly and accurately predicted Citigroup's demise during the 2008 financial crisis has become a market tout and a flaky one at that.

Just listen to her explain her investment positions, or read some of her research (as I have done) She's now billing herself as a "growth chaser," prodding investors to buy into the stock market rally despite obvious signs that the Fed might stop printing money, which would likely cause at the very least a pull back in prices.

A prudent analyst might advise caution. Whitney, meanwhile, recently said, "I have not been this constructive and bullish on the U.S. and on equities in my career."

Well that's nice to know, because a couple of years ago she was predicting something quite different in the municipal bond market. For the sake of argument, here's exactly what Whitney said back in 2010, in an interview with 60 Minutes that started the trouble.

"There is not a doubt in my mind that you will see a spate of municipal bond defaults. You can see 50 sizable defaults. Fifty to 100 sizable defaults. More. This will amount to hundreds of billions of dollars worth of defaults."

She later added that "it'll be something to worry about within the next twelve months."

The result was investor panic with small investors dumping their holdings at a time they probably should have been buying muni bonds. The reason: munis are tax exempt. The smart money knew that in a time of rising taxes (particularly in states like New York and California) muni's would be a pretty good investment.

Whitney should have known that.

She should have also known that since she works on Wall Street (which underwrites the bonds of states and cities) that muni defaults occur all the time even if for the most part muni bonds are pretty safe. "Sizable" defaults (as opposed to some fiscally distressed municipality or a tax-exempt hospital bond) are almost non existent -- which made her prediction so scary and when you think about it for a few moments so utterly absurd.

If you took Whitney at her word, the financial crisis that swept Wall Street was now about to sweep state and local government. This sounds plausible but like most of what Whitney predicts the kernel of truth obscures a larger absurdity.

Yes cities and states face enormous pressures since the financial crisis because of lower employment levels, and thus lower tax collections. But one of the triggers of the financial crisis was that Wall Street firms that had limited access to capital to run their operation.

But states and cities have access to their own form of capital; even basket cases like California have raised taxes to meet budget demands since the 2008 financial crisis. They can also cut their budgets, which they have doing as well.

In other words, there was no immediate crisis that investors needed to react to as they did in '08 when bank stocks crashed. Again Whitney should know all of this.

Whitney has since clarified her remarks saying she was only predicting the beginning of a crisis. Nice try. Even by her standards a few municipal bond defaults in places like Sacramento don't translate into something called "sizable."

Maybe my biggest gripe with Whitney is that at bottom, she had no research to back up her claim of muni Armageddon.

How do I know this? I've reviewed the research report her warning was allegedly based off of. It was titled "The Tragedy of the Commons." The real tragedy was that she didn't release it publicly. If she did, the same investing public who dumped their shares based on her 60 Minutes appearance would have known she made no similar prediction in the report -- not even close.

It was simply a state-by-state budget review and a pretty boring one at that.

I can't imagine her book being any better.