Munis in Mind (Part 1)

Are we headed for a municipal meltdown?

That’s what Meredith Whitney thinks. The former Oppenheimer analyst who correctly predicted Citibank’s demise has released a 600-page report in which she claims that municipal finance is the next sub-prime bubble. In the report she evaluates the finances of the fifteen largest states—representing two-thirds of the US economy—and finds them wanting.

She doesn’t expect the states to default, but she does think that they will reduce their transfer payments to cities and towns. Since those governments are indebted, they’ll default. And while the states may get Federal help, smaller governments won’t. She claims that a wave of defaults may be just around the corner.

There are a number of significant problems that I have with this analysis, but I’ll focus on just two. First, what makes Meredith Whitney qualified to evaluate public finance? Yes, she can read an income statement and a balance sheet, but she seems shocked, shocked that municipal accounting occasionally gets creative. Hello—have you heard of New Jersey or San Diego? They got seriously spanked by the SEC for playing fast and loose with their pension numbers.

Which is another issue: Ms. Meredith is all het up over retirement costs. She doesn’t think that the states will be able to pay them. That’s a reasonable concern, but the governments have a remedy. It’s called legislation. Retirement formulas can be altered, or the whole mess can even be outsourced to Social Security. That’s what Maine just did.

There are plenty of other questions the report raises: why is real-estate a factor when it’s a minor item in most state budgets; or what about the thorny constitutional issues involved in Chapter 9? But my biggest concern is this: is Meredith Whitney just pumping up Meredith Whitney, Inc. Who benefits from all this publicity?

Douglas R. Tengdin, CFA
Chief Investment Officer
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