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Charles Gasparino

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Meredith Whitney Doubles Down on Wrong

Posted: 06/08/11 06:04 PM ET

Meredith Whitney says she "can't believe I'm the only person talking about" the big budget problems facing states and cities these days and that investors in municipal bonds should be cautious. The reality, of course, is that she isn't and hasn't been ever since the financial crisis, the Great Recession and the obvious failure of Obamanomics to spur job growth led to a sharp reduction in tax receipts and budget deficits across the country.

But that's only one of the many dubious and sometimes bizarre statements to come out of Whitney's mouth lately as she humps a new report on the municipal bond market while she scrambles to rehabilitate her reputation and possibly her career now more than six months after she predicted an Armageddon in the municipal bond market that isn't coming and probably wont ever come.

Whitney, of course, has gained almost as much fame for what she got right as for what she got wrong. She was among the first Wall Street analysts to correctly predict the banking crisis back 2007 when the likes of former Treasury Secretary Hank Paulson said the banking system was getting better. She went on to stardom, left her old firm, Oppenheimer, and started her own.

But then late last year the former banking analyst dived into the municipal bond market with her now infamous call that over the next year, municipal bonds would default in droves. Her exact call: 50 to 100 major issuers of debt, meaning big cities and possibly states would simply walk away from their obligation on what she said would equal hundreds of billions of dollars in defaults.

The prediction was at the very least audacious; there haven't that many defaults including during the Great Depression. But she said she had research to back it all up, and this was, after all, the great Meredith Whitney. With that, investors panicked, while states and cities found it difficult to raise money by selling debt.

Whitney's star, meanwhile, grew brighter and brighter as she pumped up her prediction on select television shows like 60 Minutes and CNBC where certain reporters are either too stupid or too timid to challenge her on whether a market that has weathered past recessions pretty well would simply fall apart.

It all seemed to be working out fine for Whitney until people realized how outrageous her prediction really was. As bad as the economy is and will be for awhile, states and cities have a way of coping with budget pressures: They cut stuff or raise taxes. And that's exactly what happened and will continue to happen.

Then came the reality of her vaunted research: There really wasn't anything to back up her default claim. Her report, first obtained by the Fox Business Network, included none of the dire warnings about defaults that she made in her TV appearances just more stuff we already know: Some states face bigger budget issues than others.

And with that Meredith Whitney became known more for what she got wrong than what she got right. Richard Lehmann, who runs Income Securities Advisers Inc., which tracks muni defaults, puts into context just how badly Whitney has missed the mark. He says that so far this year there have been around $700 million in defaults -- not billion but million. Based on trends and patterns, Lehmann can see possibly another $1 billion to $2 billion, though he thinks that's unlikely. Analyst Dick Larkin offers a more pessimistic view of the market; he says under the very worse case scenario, default might reach $20 billion, but they probably wont be many states and big cities, but rather small muni bond issuers that finance quasi-private projects like hospitals.

Which is why Whitney seems now to be hitting the panic button. In promoting her new report (which again, she wont release to the press) Whitney in one breathe channels Lloyd Blankfein, the Goldman CEO who said he was doing "God's work." She talks about how she's one of the few analysts with the guts to point out how cities and states are in such desperate shape. In fact, she seems to take credit for what governors like Chris Christie in New Jersey and Andrew Cuomo in New York have done; namely cut their budgets without massive tax increases, and address bloated pension costs for public workers.

"Shedding light on this," she told CNBC this morning, "hopefully gives political will behind governors to do the right thing. If people want to attack me okay."

She's also given new meaning to the word "default." In Whitney's world, it no longer merely includes those instances where a municipality reneges on its obligations, but also refinancings or as she calls them "restructurings" of debt, in which issuers can replace old debt with new bonds at lower interest rates. The absurdity of her semantics is that using her definition, every homeowner who refinanced his or her mortgage over the past year mortgage would also be in default.

Then she throws around terms like "social contract defaults," apparently to make the numbers behind her prediction appear to be working. Her rationale is that "taxpayers are paying the same or more and getting lower services," thus the government has defaulted on its contract with taxpayers. Okay, but Whitney fails to realize that those defaults are actually good for investors because lessens the likelihood for a real default since there's more money to pay off bond holders.

The biggest about-face of them all: Whitney now says that she never meant that all those defaults would occur over one year, but something that will occur over the "course of the cycle." And how long is the cycle? One year, 5 years, 30 years? She doesn't say and the CNBC reporters, true to form, don't ask.

Whitney of course might ultimately be right that there might be hundreds of billions of defaults over the course of "the cycle," particularly if that cycle lasts the next decade, but I'm not holding my breathe, and neither should investors.