The MUNI-
MELTDOWN
THAT WASN’T.
November 2014
SPONSORED BY
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MUNI MANIA: A TIMELINE
FEBRUARY 2009
“If a few communities stiff their creditors
and get away with it, the chance that others will follow in their footsteps will grow.”
– Warren Buffett
APRIL 2009
Moody’s assigns the U.S. Local Government Sector a negative outlook
SEPTEMBER 29, 2009
“Dark Vision: The Coming Collapse of the
Municipal Bond Market”
– Frederick J. Sheehan, published
by Weeden & Co.
DECEMBER 2009
“Are State Public Pensions Sustainable?”
– Joshua D. Rauh
MARCH 30, 2010
“State Debt Woes Grow
Too Big to Camouflage”
– The New York Times
APRIL 15, 2010
APRIL 4, 2010
“Once a few municipalities default, there is
a risk of a widespread cascade in defaults.”
– Richard Bookstaber, blog
“This isn’t capitalism. It’s nomadic thievery.”
– “Looting Main Street,” by Matt Taibbi, Rolling Stone
SPRING 2010
SUMMER 2010
“How to Dismantle a
Muni-Bond Bomb”
– Steven Malanga, City Journal
OCTOBER 5, 2010
“Cities in Debt Turn to States,
Adding Strain”
– The New York Times
NOVEMBER 29, 2010
“Give States a Way to
Go Bankrupt”
– David Skeel,The Weekly Standard
DECEMBER 19, 2010
“Hundreds
of billions”
– Meredith Whitney, on 60 Minutes
JANUARY 20, 2011:
“Misunderstandings Regarding State Debt, Pensions,
and Retiree Health Costs Create Unnecessary Alarm”
– Center on Budget and Policy Priorities 21-page white paper
“Beware the Muni Bond Bubble: Investors are kidding themselves if they
think that states and cities can’t fail.”
– Nicole Gelinas, City Journal
SEPTEMBER 2010
“The Tragedy of the Commons”
– Meredith Whitney
NOVEMBER 16, 2010
“California will default
on its debt.”
– Chris Whalen to Business Insider
DECEMBER 5, 2010
“Mounting Debts by States
Stoke Fears of Crisis”
– The New York Times
DECEMBER 24, 2010:
“I can’t make the numbers work. If you look at the 10 largest
cities and the 25 largest counties in the country, that’s $114 billion in debt outstanding. So you gotta basically have New York,
Chicago, Phoenix, Los Angeles — these cities start to default.”
– Ben Thompson, Samson Capital, on CNBC
AUGUST 2011:
“[I don’t care about the] “stinkin’ municipal bond market.”
– Meredith Whitney to Michael Lewis
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INTRO
An old-media kind of guy, I still keep file folders of stories, blog
entries, clippings, messages and reports printed out and more or
less sorted. Back in early 2009, I started a file labeled “Hysteria’’
to hold the physical evidence of what I thought the most unusual
and even outlandish claims being leveled against an asset class I
have spent 33 years writing about — municipal bonds.
Over the next couple of years, the file swelled. I started another. And another. I didn’t
even include Meredith Whitney. She got an entire file of her own.
I collected so much material that I decided to use it as a presentation to the Bond Attorneys Winter Workshop one year. Even then I only got to use the high-points, or low
points, if you prefer, entering each exhibit into evidence. I considered this clever.
Inside
In the Beginning
Particular and Specific......................5
The Undiscovered Country
Just Look!..........................................8
The End of Something
Splendid Isolation No More...............9
‘Dark Vision’
Bombs Away...................................10
“Show me a revenue stream and I’ll show you a bond issue,” is an old banker’s axiom.
The writer’s equivalent is probably, “Show me a box of research and I’ll show you a book.”
Or, in this case, a special supplement. And so here we are.
The Coming Collapse
In Sum............................................. 11
In 2010, municipal bonds, hitherto known only as secure, boring investments, if sometimes a little weird, were front-page news. It was stated with some confidence that the
entire market was going to go bust.
Into the Abyss
‘Dump Munis’...................................12
Of the Great Municipal Market Meltdown – so confidently predicted for 2010, 2011, 2012,
and so on – I think we are now finally able to say, “That didn’t happen.” As it was being
predicted, I observed that the reason it wasn’t happening was because “that doesn’t happen.” In other words, the various “experts’’ then weighing in about state and local governments’ coming mass insolvency and/or repudiation didn’t know what they were talking
about. That didn’t stop what I termed their “Inexpert Testimony” from being offered. And
widely (and unfairly, I thought) quoted.
I define “meltdown’’ here as its proponents did: widespread default or outright repudiation
of municipal bonds. There were a number of (non-muni) analysts and observers eager to
forecast just this possibility. Others contented themselves with stoking hysteria in regard
to public pensions. One even expressed outrage over Wall Street’s underwriting and
banking relations with Main Street borrowers. The blowup to come, we were assured,
was going to be almost operatic.
The more I leafed through these bulging files — in retrospect, and recollected in tranquility, as the poet says — the more I asked, How did this come about? Why were so many
people who were little more than tourists in MuniLand taken so seriously?
Why was the opinion of those who did know what they were talking about so heavily discounted? What lessons can investors learn from this? Because lots of investors,
especially after Meredith Whitney made her famous call on “60 Minutes” in December
of 2010, sold both muni mutual fund shares and individual bonds, sometimes at fire-sale
prices. They wanted to get out at any price. Panic was in the air.
Public Pensions
We Have a Problem.........................13
Media Frenzy
Everyone’s Meltdown.......................16
The Market Responds to Its Critics
First Responders.............................19
Oh, Meredith
‘Hundreds of Billions’.......................23
After ‘Hundreds of Billions’
Victory Lap......................................24
Returning Fire
That’s Enough!.................................26
What Happened, Lessons Learned
Age of Twitter...................................27
Appendixes
To the Foregoing Work....................30
There’s no one answer. There are lots of answers.
There’s no one answer.
There are lots of answers.
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I: In the Beginning
Our story begins in 2009. There may have been hysterical commentary
about the condition of the municipal bond market before this. There
probably was; I just don’t recall it. Maybe it lacked a certain intellectual
heft, and so had little impact on me as I read it. More likely, it was submerged in the round-the-clock hysteria then surrounding nothing less
than the state of capitalism in the free world. The recession that had
begun in late 2007 and accelerated in 2008 still had a way to go.
Faced with Wall Street firms going bust,
mass firings, the housing price collapse
and 401(k) plans evaporating as the stock
market plummeted, it was hard for municipal bonds to make the front page.
They tried. Two events in particular had
rocked munis in 2008. In February, the
$330 billion auction-rate securities market
froze after Wall Street banks stopped
providing backstop bids for the stuff. The
market had long relied on a convention
the Street could no longer afford – instant
liquidity. The result: Investors in many
auction issues could see their money, but
couldn’t lay their hands on it. It would take
years to remedy the situation.
Rise of the Insurers
This was damaging enough to the market’s psyche. Even worse was the downgrade of most of the AAA-rated municipal
bond insurers. Bond insurance was perhaps the most successful franchise in the
municipal bond market, originating in 1971
and reaching a peak penetration of 57
percent of the new issue market by 2005.
Bond insurance was also the thing that
“commoditized’’ the market. No longer did
investors have to study the innumerable
details of a bond issue’s structure and
security. Now there was just this thing you
could buy called a municipal bond that
produced interest that was tax-exempt and
that was incredibly safe and secure in the
first place and was now even insured as to
repayment of principal and interest and so
rated AAA. Or so it was thought for a very
brief period stretching from perhaps 1985
to the collapse of the insurers in 2008.
The insurers had proven to be in the
right place at the right time. They were
even, helpfully, a little early. States and
municipalities were just about to embark
on a borrowing binge, spurred in part
by the threat, real and imagined, of tax
reform that would prohibit them from
financing certain things with tax-exempt
securities, and then by a decline in interest rates that sparked a wave of refinancing, and finally by a boom in what we may
term bankerly creativity. I’m sure the rise
of suburbs beyond the suburbs and their
concomitant needs for infrastructure like
streets and sewers and schools was part
of it, as was the later urban renaissance.
Analysts could take cold comfort in the
fact that the insurers didn’t lose their AAA
ratings because of anything they’d done
in the municipal market. Their sin was
expanding into asset-backed securities,
a move inspired as much by stockholder
interest in returns as demanded (well,
almost) by the ratings companies, which
urged the insurers to expand into more
lucrative areas of business.
And here it might be appropriate to say
why commoditization was so welcomed in
this market. As investor Paul Isaac once
put it to me over cocktails, “So what you’re
saying is, municipal bonds are particular
and specific to a remarkable degree.’’
Isaac was responding to my amazement and frustration trying to understand
a subject that seemed endless and
unfathomable. This was back in the early
1980s. I stole his phrase and have used it
ever since, only occasionally substituting
“insane’’ for “remarkable.’’
This turned out to be the single most
important observation about municipal
bonds I have ever heard. It explains so
much. It explains everything.
The multifarious (“of great variety;
diverse’’ according to Webster’s) nature
of municipal bonds is one of the reasons
Source: Nick Ferris/Bloomberg
Joe Mysak
I became so convinced that a national
meltdown was unlikely. We’re not talking
about dozens or scores of issuers, but
tens of thousands.
The Census of Governments done by
the U.S. Census Bureau every seven
years shows that there are just over
90,000 governmental entities in the U.S. It
has been estimated by the Municipal Securities Rulemaking Board, the market’s
self-regulatory organization, that perhaps
50,000 have borrowed money in the municipal market at some time or other.
They have done so with serial and term
bonds, with notes, with variable- and the
aforementioned auction-rate securities,
using their full-faith and credit taxing
power pledge, their limited taxing power
pledge, their mere promise to appropriate
money for debt service, and more often
than not (since the 1970s), with the promise of specific revenue streams. And did I
mention the companies, like airlines, that
also borrow in the municipal market?
Sucker’s Bet
In fact, it’s a rare government that uses
its general obligation, full-faith and credit
pledge to sell bonds to borrow money.
What was once termed the shadow government, and not in an approving way, is
the primary engine of borrowing in today’s
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muni market: a network of districts, agencies, authorities and public corporations,
staffed by their own professionals and
insulated, if you will, from the public and
even from duly-elected government officials, like a city council, for example. The
decentralized nature of municipal issuance turns out to be one of the market’s
great strengths.
Add to this the perpetual nature of most
governmental entities and you can see
why a mass municipal meltdown was a
sucker’s bet. Perhaps only someone who
has looked through 12 or 20 screens of
a Bloomberg terminal’s “Municipal Bond
Ticker Look Up’’ can appreciate this. Type
in a name of a municipal issuer and you
get screen after screen of apparent direct
relations. Who are all these guys? The
auction-rate freezeout and the collapse of
the bond insurers were stunning stories,
unimaginable for anyone familiar with the
things, yet in the context of the times in
2008 just more collateral damage from the
subprime mortgage implosion.
More bad news was on the way in 2009,
as the recession deepened and states
and municipalities saw tax revenue dwindle. The recession officially ended in June
of 2009. State tax collections declined
versus the same period the previous year
in every quarter from the fourth quarter
of 2008 to the fourth quarter of 2009,
according to the Nelson A. Rockefeller
Institute of Government.
That’s another feature of the municipal
market; state and local government isn’t
on the front end of recession, but on the
tail. Public finance is a lagging indicator.
This is why most states and municipalities were still hiring in 2008, even as the
private sector was shedding hundreds of
thousands of jobs.
Acronym Mad
Now we come to the first major market
“call’’ that attracted my attention as being a little exaggerated if not hysterical.
Because, let’s face it, Warren Buffett is
no hysteric.
The reference to munis came in the
February 2009 edition of the letter Buffett
sends annually to Berkshire Hathaway
shareholders. Berkshire had launched
Berkshire Hathaway Assurance Company
(or BHAC: the bond insurance business
is acronym-mad) in 2008 as a municipal
bond insurer. Under a section of his letter
entitled, Tax-Exempt Bond Insurance,
Buffett recounted BHAC’s year, which at
one point included an offer to reinsure the
other largest monoline municipal bond
insurers’ existing books of business. The
insurers rebuffed the offer.
Buffett said BHAC would “remain very
cautious about the business we write and
regard it as far from a sure thing that this
insurance will ultimately be profitable for
us. The reason is simple, though I have
If a few communities stiff their
“creditors
and get away with it, the
chance that others will follow in
their footsteps will grow.
— Warren Buffett
”
never seen even a passing reference to it
by any financial analyst, rating agency or
monoline CEO,’’ Buffett wrote.
He continued, “The rationale behind
very low premium rates for insuring
tax-exempts has been that the defaults
have historically been few. But that record
largely reflects the experience of entities
that issued uninsured bonds. Insurance of
tax-exempt bonds didn’t exist before 1971,
and even after that most bonds remained
uninsured.’’
Buffett continued: “A universe of tax-exempts fully covered by insurance would be
certain to have a somewhat different loss
experience from a group of uninsured, but
otherwise similar bonds, the only question
being how different. To understand why,
let’s go back to 1975 when New York City
was on the edge of bankruptcy. At the time
its bonds — virtually all uninsured — were
heavily held by the city’s wealthier residents as well as by New York banks and
other institutions. These local bondholders
deeply desired to solve the city’s fiscal
problems. So before long, concessions
and cooperation from a host of involved
constituencies produced a solution. Without one, it was apparent to all that New
York’s citizens and businesses would have
experienced widespread and severe financial losses from their bond holdings.’’
If, Buffett posited, all of the city’s bonds
were insured by Berkshire, would “similar belt-tightening, tax increases, labor
concessions, etc.’’ have been forthcoming? Of course not, he answered. “At a
minimum, Berkshire would have been
asked to ‘share’ the required sacrifices.
And, considering our deep pockets, the
required contribution would most certainly
have been substantial.’’
In other words, the city would have
defaulted on its insured bonds, leaving
the insurer to pay the debt service. At
some point, it is assumed, the city and the
insurer would sit down and negotiate the
terms of repayment, but not in full.
‘Simply Staggering’
Buffett observed that local governments
were going to face far tougher fiscal problems in the future. “The pension liabilities I
talked about in last year’s report will be a
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huge contributor to these woes. Many cities and states were surely horrified when
they inspected the status of their funding
at year-end 2008. The gap between assets and a realistic actuarial valuation of
present liabilities is simply staggering.’’
So far, so good. New York City’s nearmiss with bankruptcy, I know, was a closerun thing, with the state playing a powerful
role in the rescue, along with the United
Federation of Teachers.
Buffett’s theory of the role insurers
might play in a meltdown was somewhat
prescient, as the Detroit bankruptcy has
shown us: the insurers have a seat at the
table, and are indeed expected to “contribute’’ to Detroit’s future, by taking less than
they are owed by the city.
Buffett’s concerns about public pensions
were nothing new or astonishing. Numerous analysts pointed out how they had suffered after the tech bubble burst only a few
years before. (It is worth noting, however,
that in 2000, the so-called funding ratios of
public pensions topped 100 percent).
And then Buffett went just a little bit further.
“When faced with large revenue shortfalls, communities that have all of their
bonds insured will be more prone to
develop ‘solutions’ less favorable to bondholders than those communities that have
uninsured bonds held by local banks and
residents. Losses in the tax-exempt arena,
when they come, are also likely to be
Municipal bonds are
“particular
and specific to
a remarkable degree.
”
– Paul Isaac, Investor
highly correlated among issuers.’’
This last sentence can be parsed any
number of ways, and I’m not going to attempt it here.
But then, this: “If a few communities stiff
their creditors and get away with it, the
chance that others will follow in their footsteps will grow. What mayor or city council
is going to choose pain to local citizens in
the form of major tax increases over pain
to a far-away bond insurer?’’
Buffett concluded that insuring municipal bonds “has the look today of a
dangerous business.’’
The headline words were “dangerous
business.’’ The real story was in the previous two sentences, about 1) a seeming
contagion in municipalities
actively seeking to stiff their creditors and
“get away with it,’’ and 2) elected officials
choosing not to make some very hard
choices.
I didn’t know it at the time, of course, but
the Buffett letter was the first salvo in what
would become a muni meltdown barrage.
At the time, I thought it interesting, purely
because munis were so unremarked upon
in general. I also thought it a trifle overwrought, said so in a column, and was
surprised at how many e-mails I received
from the Great Man’s minions, eager to
denounce unbelievers. Much worse was
to come.
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II: The Undiscovered Country
There wasn’t a lot of big press coverage of
municipal finance because editors found
the topic almost stupefyingly dull.
Everybody’s Talking
Source: Bloomberg/Daniel Acker
Warren Buffett
In 2008, Buffett made his overtures to
the beleaguered bond insurers. The possibility that they might lose their top credit
ratings was already a hot topic of conversation among market participants, not
least because investor Bill Ackman was
shorting the stock of the biggest insurer,
MBIA, and he made sure the Wall Street
Journal knew it.
But there were a lot of other things being
discussed in the municipal market, as
well. How would a decline in tax revenue
affect budgets and credit ratings? How
would states and municipalities deal with
stock market losses that had blown a hole
in the value of the assets they had put
away to cover pension liabilities? Could
they manage the expense of “Other PostEmployment Benefits,’’ previously handled
mainly as a pay-as-you-go expense?
Then there was the SEC’s ongoing investigation into bid-rigging and price-fixing
in the municipal reinvestment business,
the whole murky world that exists after
issuers sell bonds and need to invest the
proceeds. The use and proliferation and
opacity of swaps was finally getting some
attention, too.
The Municipal Securities Rulemaking
Board, for its part, was in the midst of a
push to reform disclosure and enhance
price transparency, as well as regulating municipal advisers and establishing
who owed issuers fiduciary responsibility,
among other things.
Yes, all of these topics were being discussed in the muni market. Just because
these subjects only sporadically appeared
in the major newspapers and almost
never made it to television and cable news
doesn’t mean that they weren’t being
talked about, and covered by local newspapers and the very specialized financial
press, that write about munis. There was
a lot of ferment going on in municipals in
the 2000s.
And yet, a common claim among those
who would stoke the muni meltdown
hysteria was that “nobody’s talking about
this,’’ as if an almost $3 trillion market (at
the time) was somehow being conducted
entirely in secret — and I have been a
critic of how private public finance can
sometimes be.
Or they would claim, “the experts’’ (whoever these people were supposed to be;
perhaps even I was one of them) were so
conflicted that they couldn’t possibly see
this or that self-evident truth.
The other side of the argument, of
course, is that nobody was talking about
“it’’ (whatever it happens to be), because
“it’’ isn’t true.
The mainstream media, as they call it
nowadays, has always had a problem with
the municipal market. Municipal bonds
are hard to understand. Bankers and the
many financial professionals who assist
public officials in their bond sales tend to
follow a code of silence. The sales and
trading of municipals is done over the
counter, almost on a bespoke basis.
The press loves a simple story, and
public finance is extremely nuanced. The
relatively high cost of entry for investors
(you need tens of thousands of dollars
to invest in munis, a few hundred to buy
stocks) means that municipal bonds aren’t
really even part of the financial “culture,’’ in
the way that stocks are.
Tourists in MuniLand
There wasn’t a lot of what I’ll call big
press coverage of municipal finance because editors found the topic stupefyingly
dull and so, they reasoned, few people
would care to read about it. I sometimes
think I would have had more readers if I
wrote about Hummel figurines, or numismatics, rather than munis.
Beginning in 2009, more people were
claiming that the municipal market was
the undiscovered country. Just look at
what we’ve found, these critics — tourists
in MuniLand — would say. And, no surprise, the story they so often brought back
was very similar to the stories that tourists
tell: by turns frightening and amusing, and
of limited long-term value.
Never had so many been so misled by
so few with such little actual expertise.
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III: The End of Something
The municipal market’s long period of
splendid isolation, if we can call it that,
was all about to end. The story of the
market meltdown that wasn’t is very much
a story of the media.
To repeat: Nobody was saying that
states and municipalities were not facing
some pretty stiff headwinds as a result of
the real estate bubble and recession.
What made this time different is that
house price declines played out nationally
rather than, as is usual, regionally. There
were of course some markets that fared
much better than others, but prices fell
everywhere.
In April 2009, Moody’s assigned a
negative outlook to the U.S. Local Government Sector, saying, “This is the first
time we have assigned an outlook to this
extremely large and diverse sector. This
negative outlook reflects the significant
fiscal challenges local governments face
as a result of the housing market collapse,
dislocations in the financial markets, and
a recession that is broader and deeper
than any recent downturn.’’
Note the language: “significant fiscal
challenges.’’
I had long been a fan of the restrained,
sober style the analysts at the rating companies had learned to use (it was, I was
informed, very much a learned style). If
you were unaccustomed to the style, you
could read through thousands of words of
analysts’ prose and not quite know what
they were really saying, or if they were
saying anything at all.
Not this time. The company continued,
“Sharply falling property values, contracting consumer spending, job losses, and
limited credit availability lead the long list
of developments that will make balancing
budgets in the coming year particularly
difficult. The negative outlook assigned to
the U.S. local government sector encapsulates our view on this challenging
environment and the strains that will be
evident in credit for issuers across the
industry.’’
This was a very well-crafted, detailed
piece of work in nine pages. I was impressed by the – for them – blunt tone as
well as the way it reminded its readers
that this was a big market, particular and
specific to a remarkable degree, in the
words of my friend Isaac.
Again, Moody’s: “Credit pressures faced
by local governments and their responses
to these pressures will vary significantly
across and within states due to uneven
economic conditions, differing revenue
mixes and service mandates, inconsistent
property assessment practices, and different levels of revenue raising authority. The
governance strength of individual issuers
and behaviors which demonstrates their
willingness and ability to adapt to that environment will determine the overall trend
in individual ratings.’’
The rating company put the entire sector
on negative outlook. It didn’t say that the
entire sector would respond in the same
way to the extraordinary, “unprecedented’’
pressures then accumulating: unemployment at more than 8 percent, stock prices
off 50 percent, home prices down an average 25 percent from their peak. And what
might be the result? “Increased rating
revisions’’ for local governments.
This was an extremely reasonable, clear
piece of work from a generally recognized authority on the subject. Unhappily,
because of their role in the subprime
mortgage collapse, the rating companies in
general had forfeited a certain credibility by
this point, even in the municipal market.
An earlier announcement by Moody’s in
March of 2007 that it would stop using a
dual scale to rate municipalities and corporations had touched off a controversy
that once would have dominated market
conversation. Now, in the midst of the
recession, it was almost an afterthought.
Moody’s and Fitch finally recalibrated
their ratings in 2010; Standard & Poor’s
announced a change in its own methodology for rating municipalities soon after.
Looking back at 2009, I am surprised by
just what a newsy year it was in municipals. Jefferson County, Alabama, was still
trying to avoid bankruptcy. Municipalities were starting to file lawsuits against
those Wall Street firms that had sold them
swaps and derivatives.
In August, the MSRB said it was looking
at “flipping’’ in the muni market, apparent
in glaring fashion soon after states and
municipalities started selling federallysubsidized Build America Bonds.
A federal grand jury would finally indict
CDR Financial Products, the firm at the
red-hot center of the market’s bid-rigging
scandal, at the end of October.
There was a time I used the expression “bullets don’t grow on trees’’ from the
movie “Michael Collins,’’ to characterize
actual municipal market news, and to caution reporters to husband story ideas with
care. No longer. In 2009, it seemed like
news was breaking every day.
Then one day in October, I got an e-mail
from a reader. His name was familiar to
me as someone who occasionally commented on my columns. He attached a
report that he said he found compelling.
This is the first time we have
“assigned
an outlook to this large
and diverse sector.
”
— Moody’s
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IV: ‘Dark Vision’
I wish I saved that first e-mail, so I could
give proper credit to the sender. In the
weeks to come, more correspondents
would forward me the same report, most
accompanied by a message written in a
tone of resignation and dismay. One even
sent me a copy in the mail. People wanted
to make sure I saw this thing
The report was “Dark Vision: The
Coming Collapse of the Municipal Bond
Market,’’ published by Weeden & Co. for
its clients. It was a “guest perspective’’ as
they called it, by Frederick J. Sheehan.
This was the first piece I had ever seen to
call for the municipal market’s imminent
meltdown. It was also the first piece to
demonstrate to me that the muni market
was entering a new media age.
I originally dismissed it. I glanced at that
title, winced, and put it aside. Weeden &
Co.? They weren’t in the municipal market.
Frederick J. Sheehan? Who was he? I
hadn’t seen him on the muni beat before.
“The Coming Collapse of the Municipal
Bond Market’’? Please.
It really wasn’t until I spotted it again, this
time in a reference to a business blog on
yet another financial news web site, that I
realized that the market had a problem. In
the new Internet age, anyone could write
anything and it could achieve the credibility and authority of “publication.’’
Anything Goes
And it metastasized. An article or report
was no longer published once, but again,
and again, and again, all over the Internet.
The new reporters, or editors, or whatever
you called them, sometimes did no more
than put an inviting and often sensational
headline on a short summary, and then
provide a link to the actual underlying
document, story, report, lawsuit, opinion
piece, whatever it happened to be. And
then dozens or scores of readers could
comment on it, further legitimizing the story,
no matter how inane their own commentary.
In the new Internet age, anyone could write
anything, and it could achieve the
credibility and authority of ‘publication.’
In this publication democracy, it seemed,
everything was valid, all points of view legitimate. It would take some time, for me,
to realize that the key thing in this transaction was for the author to say something,
usually bad, was going to occur, and very
soon. This seemed to be the only criterion
for the new “publication’’ world: Something Bad Is Going To Happen. This got
you clicks, this got you viewers, this got
you subscribers, this got you on television, and, in some cases, it got you book
contracts.
In fact, more often than not, in public
finance as in most people’s lives: Nothing
happens. Things muddle along, things
work out, or not, in slow and usually
unspectacular fashion. Especially, might I
add, in the municipal bond market, where
trading in a new issue typically ceases
after about 30 days, and where time is
measured with a calendar.
“The Coming Collapse of the Municipal
Bond Market’’? The timing of this piece
was propitious. The Great Recession,
it seemed, had just ended in June, but
people were still ready to believe anything
about everything. “The Coming Collapse
of the Municipal Bond Market’’? Why not?
FOLLOW JOE MYSAK ON TWITTER
FOR REGULAR UPDATES AND ADDITIONAL INSIGHTS
Hysteria Begins
“Dark Vision’’ was dated Sept. 29, 2009.
This is when I date the kickoff of the Muni
Market Meltdown Hysteria. So many
things came together at this precise moment: the rise of the Internet; the explosion of business and financial news web
sites (it is worth noting that Business
Insider only began in 2007); more cable
business coverage; the greatest recession since the Great Depression; the 24/7
news cycle.
Only a few years later, I suspect, any
such “meltdown’’ call would have been
mitigated, even refuted, by the very same
Internet that had given birth to it. Twitter
would kill it.
But in 2009, most of those who knew
anything about the municipal market
weren’t tweeting. “Bond Girl,’’ for example,
didn’t start tweeting until April of 2011,
Reuters’ Muniland blogger Cate Long in
July of 2010.
Inexpert testimony was set for a very
brief reign in the muni world.
>>>> @joemysak
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Bloomberg Brief | Muni Meltdown 11
V: The Coming Collapse of the Municipal Bond Market
Source: Bloomberg/Andrew Harrer
Alan Greenspan
The most remarkable part of “Dark Vision’’
was the title and subhead. For the uninitiated,
“Dark Vision’’ looked plausible enough, with
various bits of data and almost two pages of
scholarly-looking footnotes. The more I read
it and considered it, the more I realized it was
little more than a series of assertions, without
a lot of proof.
The author had written a couple of books
critical of Alan Greenspan and the Federal Reserve, according to the identifying
note attached to the piece. I got the feeling,
as I was reading, that he was grinding a
libertarian axe. Political point of view and
credit analysis usually don’t mix well.
I don’t want to spend too much time on
“Dark Vision,’’ which I found unpersuasive, so
let me try and summarize.
It is time to get out of municipal bonds,
says Sheehan.They are now to be considered
speculative investments, and buyers are just
not being compensated enough for the risk
they are taking. Fair enough, I thought.
“The municipal market will probably repeat
the pattern of the sub-prime collapse,’’ he
wrote. “Although it is plain to see, the usual
experts do not notice.’’ He doesn’t say who
these experts are, although I infer that they
are the rating companies.
He describes the “mess’’ in public finance:
“Recent cost-cutting by states and municipalities is inadequate. This much is probably obvious. What may go unrecognized
is that filling these gaps using conventional
measures is impossible. Parties to suffer
from unconventional measures include
bondholders.’’
This pretty much sums up the Sheehan
argument. States and municipalities spend
too much, borrow too much, promise too
much to their employees. Faced with the
“impossible,’’ many municipalities will seek
bankruptcy court protection.
Bondholders can’t rely on issuers’ pledges to levy taxes to pay debt service. Nor
can they trust that the courts will ensure
that they are paid.
Had Sheehan limited his remarks to “Detroit,’’ I might have hailed him as a visionary
today. Had he somehow limited his thesis
to “some’’ or even “a handful’’ of municipalities, even that would have been somewhat
acceptable. But no. The entire market will
“collapse.’’ On the other hand, who wants
to publish “The Coming Collapse of an Infinitesimal Number of Municipalities’’? Who
would read it, beside the hard core?
That all states had borrowed too much
was a typical canard. Taking a look at
Moody’s annual State Debt Medians Report published in July of 2009, the author
could have seen that net tax-supported
debt per capita drops fairly quickly after
you look at the top 10 states. In first place
was Connecticut, at $4,490; in 10th was
California, at $1,805. In 30 of the states,
the figure was below $1,000.
A similar story could be told about public
pensions, as well as public employee pay.
A few states were bad at making their
actuarially-required contributions to their
pension systems. Some states and cities
had sweetened pensions, and salaries,
without much apparent regard of how to
pay for them.
And then there were some errors:
“Current bond issues will need to be
rolled over when they mature, since
budget gaps are rising.’’ Sheehan takes a
hallmark of the sovereign debt market and
transfers it to munis. That’s not how munis
work. Municipalities pay off their debts
over time, usually through the use of
serially maturing bonds. Yet this “rollover’’
error would be repeated.
Note here that Sheehan wasn’t talking
about the letters of credit or liquidity facilities backing variable-rate demand obliga-
tions expiring. This would become one of
the market’s typical non-issue issues in
2010 and 2011. As it turned out, the market
handled the, in Moody’s words, “unprecedented’’ number of expirations handily.
Sheehan wasn’t talking about VRDOs. He
was describing “the next Greece,’’ as critics
of the time put it.
“One of the largest municipal expenditures is coupon interest on bond obligations.’’ That’s not true. Debt service is
actually one of the smaller items in most
municipal budgets. As analysts would
eventually point out, why would public
officials go out of their way to anger the
investors they need and target debt service, since it would be of so little help in a
financial emergency?
Why did I go back and read “Dark Vision’’? Because more than a month after
it was published, it was mentioned on a
business news web site, which linked to
a piece on the Seeking Alpha blog, which
in turn linked to a piece on a Harvard Law
School blog, picking up approving comments from the uninformed every step of
the way.
And so the “coming collapse’’ of the municipal bond market had been announced.
In 2011, Bloomberg Brief: Municipal
Market’s Brian Chappatta asked Sheehan
what happened — why hadn’t the market
collapsed? He gave a very detailed response, which I include here as Appendix
2. I called him on Nov. 17 of this year, and
he gave me a very similar response: “One
thing I didn’t understand was how hard
states would work to pay their bonds so
they could continue to legislate. I thought
there’d be much more of a battle between
paying bonds and other expenses like
pensions. I still think that has to come at
some point, as the asset price bubble
starts to deflate. [States and municipalities] have continued to spend as if they
learned nothing from how close they did
come to defaulting in 2009.’’
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Bloomberg Brief | Muni Meltdown 12
VI: Into The Abyss
The crush of news in 2009 meant that it
took a while for the market to confront the
municipal bond meltdown scenario being
presented. The Sheehan piece achieved
what I sensed was wide circulation, showing up around the Internet without much in
the way of rebuttal.
Sheehan was first. James Chanos,
noted short-seller, appeared in Barron’s
in the Nov. 9 “Current Yield’’ column:
“Dump Munis,’’ was the headline. The
culprit: “platinum-plated health-care and
retirement benefits,’’ said Chanos. I asked
Chanos on Nov. 17 if he had any further
thoughts about the municipal market, and
he declined comment.
On Dec. 16, 2009, Standard & Poor’s
published a paper entitled “Credit FAQ:
The Recession’s Impact on U.S. State and
Local Government Credit Risk.’’
I now see this as the first defense of
munis. Whether it was done in response
to Sheehan, I do not know.
The FAQ format is, of course, a feature
of the Internet; I’m not sure how much
circulation this piece got. It was detailed
and reasonable and accurate. But of
course Collapse trumps Muddle Along in
the Internet popularity stakes.
My favorite answer came in response
to the question: “Then why do state and
local governments keep talking about the
dire straits they are in?’’ S&P said: “As this
all plays out, we think that new headlines
will likely capture elected officials’ and oth-
ers’ efforts to make the public aware of the
circumstances of their austerity measures
and what they think will be the consequences of inaction.’’
Do the Right Thing
The important thing about the S&P
piece, as well as the earlier Moody’s
commentary tagging the entire sector with
a negative outlook, was that both rating
companies expected most public officials
to do the right thing by their bondholders.
Also noteworthy, especially in retrospect,
is how S&P took pains to say how “conditions do vary.’’ Once again: particular and
specific. It’s very much like that old legal
expression: all facts and circumstances.
Even in 2009, you could see several
themes playing out here. On the one
hand, you had outside critics saying that
municipalities were all in the same boat,
that they had exhausted their resources,
and that default and repudiation were
inevitable. On the other, you had analysts
saying that it was impossible to generalize about issuers, that most of them had
plenty of resources still available to them,
and that most of them could actively manage their way out of the situation.
The final piece of the puzzle appeared at
the very end of the year, although it didn’t
gain traction until later: a white paper by
Joshua D. Rauh of the Kellogg School of
Management at Northwestern University:
Are State Public Pensions
“Sustainable?
Why the Federal
Government Should Worry About
State Pension Liabilities.
”
— Title of paper by Joshua Rauh, Kellogg School
of Management at Northwestern University
“Are State Public Pensions Sustainable?
Why the Federal Government Should
Worry About State Pension Liabilities.’’
Of course, we all know what the answer
to the title’s question was.
This was a provocative piece of work.
Up to this point, as far as I know, nobody
had predicted that pension funds would
run out of cash altogether, or that pension underfunding might drive states “to
insolvency,’’ as Rauh claimed. Rauh also
introduced his notion that state and local
pension plans should “discount the benefit
cash flows at Treasury rates.’’
In other words, they should stop assuming that the assets they had put in
their pension systems would produce 8
percent a year. Discounting benefit flows
at Treasury rates produced a gap between
assets and liabilities of $3 trillion at the
end of 2008, Rauh wrote. He also modeled which states’ plans would run out of
money, and when.
Rauh’s chief assumption was that states
would contribute enough money to their
pension plans “to fully fund newly accrued
or recognized benefits at state-chosen
discount rates (usually 8 percent) but no
more.’’ This was “broadly in keeping with
states’ recent behavior.’’
The paper itself was no easy read, but
the “Table 1: When Might State Pension
Funds Run Dry?’’ was clear enough.
Rauh predicted that Illinois would run out
in 2018, Connecticut, Indiana and New
Jersey in 2019, Hawaii, Louisiana and
Oklahoma in 2020. Alaska, Florida, Nevada, New York and North Carolina would
never run out.
Rauh is now at the Stanford Graduate
School of Business. He didn’t respond to
a request for comment. He has continued
to publish, and his views are now wellknown. It used to be that public pension
funding was one of those things covered by rating companies perhaps on a
quarterly basis. Now, it seems that we get
regular, detailed updates on their condition almost weekly. This is a good thing.
People didn’t really start to discuss the
Rauh study until 2010. This would prove to
be the cauldron year for the muni meltdown.
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11.25.14 www.bloombergbriefs.com
Bloomberg Brief | Muni Meltdown 13
VII: Public Pensions
The year 2010 was
the peak year for
meltdown mongering.
It was as if with the real estate bubble
burst, banks failing and companies from
auto manufacturers to Wall Street brokerages in bankruptcy, gloomsters could
finally turn their attention to states and
municipalities.
Not all the material being published
about public finance was incendiary.
Some was salutary. As the old saying
goes, never waste a crisis. So it was with
public pensions. In February, the Pew
Center on the States published “The
Trillion Dollar Gap: Underfunded State
Retirement Systems and the Roads to
Reform,’’ a thoughtful, comprehensive 61page study.
Pew said the difference between what
states had on hand and the pension
and other retirement benefits they had
promised amounted to $1 trillion, and that
was conservative, because it was based
on June, 2008, data and thus hadn’t taken
into account all investment losses.
The Pew report was unhysterical and
exhaustive, filled with maps and tables of
data. It showed the extent of investment
losses, and ranked how the states were
managing the situation. On pensions, it
said, 16 were solid performers, 15 needed
improvement and 19 were “serious concerns,’’ while in the area of health care
and other benefits, which most states had
treated as a pay as you go expense, 9
were solid performers in terms of quantifying the obligation and putting aside money
for it. The report also noted that 15 states
in 2009 had passed legislation reforming
some aspect of their pension systems,
usually by making new employees contribute more.
As if any reminder were needed, the
results showed how the subject of public
pensions resisted generalization. New
York’s pensions were 107 percent funded,
Florida’s 101 percent. Illinois had only 54
percent of the money it needed, Kansas
59 percent, Colorado, 70 percent.
The study also examined investment
return assumptions, just then becoming a
fat target for critics. Recall that in September 2009, Pimco’s Bill Gross coined the
term the New Normal to characterize the
low-growth, low-yield future.
The Carolinas calculated they would
earn 7.25 percent, Colorado, Connecticut,
Illinois, Minnesota and New Hampshire
8.50 percent. By far the most states, 22,
were at 8 percent, which, as the report
pointed out, was the median investment
return for pension plans over 20 years.
The report examined the factors that
contributed to the $1 trillion gap, such as
the volatility of investments, states failing
to make their annual actuarially-required
contributions and “ill-considered benefit
increases’’ during good times. It also
examined the “road to reform.’’
Of course the Internet focused on the
“$1 trillion gap,’’ and even more on the
Rauh $3 trillion gap.
A subject that had received scant attention – except among the rating companies, municipal analysts, some local
newspapers, and the blog that since 2004
collected coverage of the topic, pensiontsunami.com – was now in the spotlight.
Public pension analysis was, almost, the
flavor du jour. At least three more academic reports on public pension liabilities
were published during the year.
‘Distinct Risk to Taxpayers’
In April, the American Enterprise Institute for Public Policy Research presented resident scholar Andrew Biggs’s “The
Market Value of Public-Sector Pension
Deficits,’’ basically an endorsement of the
Rauh $3 trillion pension gap figure.
Then in June came a working paper by
Eileen Norcross and Andrew Biggs,
published by the Mercatus Center at
George Mason University entitled “The
Crisis in Public Sector Pension Plans:
A Blueprint for Reform in New Jersey.’’
Norcross and Biggs repeated the Rauh $3
trillion gap and advocated defined contribution over defined benefit pension plans.
The latter, they said, presented “a distinct
fiscal risk to taxpayers.’’
And in October, Rauh and Robert
Novy-Marx of the University of Rochester
produced a paper, “The Crisis in Local Government Pensions in the United
States’’ for a conference on retirement
and institutional money management
post-financial crisis. The authors looked
Source: Bloomberg/Andrew Harrer
‘The New Normal’: Bill Gross
at the unfunded pension obligations of
local governments, and concluded that,
if already-promised benefits were discounted at riskless, zero-coupon Treasury
yields, the total unfunded obligation for
the municipalities they studied was $383
billion rather than the $190 billion the
localities themselves calculated.
I was of two minds about the explosion
of interest in public pensions. On the one
hand, I thought it good to focus on the
subject, because it seemed that certain of
our elected representatives over time had
sweetened the salary and public pension pot in exchange for union peace and
votes, with no consideration for the way
even little enhancements add up. They
also all too often neglected to keep up
with their actuarially-required contributions
to their pension plans.
On the other hand, I objected to the “crisis’’ terminology which made it seem to the
uninitiated as if states and localities had
to come up with the money to fill the gaps
overnight. As always, I worried that generalizing about the subject was distracting.
What we really needed was focus: Which
states and municipalities had done the
worst jobs managing public pensions?
More importantly, why? These things
aren’t easy to trace, but glossing over the
subject in favor of big numbers lets the
guilty parties off the hook. What hapcontinued on next page...
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11.25.14 www.bloombergbriefs.com
Bloomberg Brief | Muni Meltdown 14
continued from previous page...
pened, when, why, and how can we guard
against it happening again?
It had taken almost
three decades, and the
dawn of the Internet
age, for me to realize
that data was not
definitive, that
analysts could make
the numbers dance.
Amplified Alarm
I think it was around this time, too, that
I became very skeptical of all “studies’’
and “reports.’’ It had taken almost three
decades, and the dawn of the Internet
age, for me to realize that data was not
definitive, that analysts could make the
numbers dance.
I also began growing impatient with
what I came to call the media’s “denominator problem.’’ Such-and-such costs “$3
BILLION dollars,’’ radio and television announcers would declare, all but reaching
a full windup to deliver the plosive “BILLION.’’ And that was fine. But it matters a
great deal if the “$1 BILLION’’ is part of a
budget, say, of $5 billion, or part of one
amounting to $50 billion or $150 billion.
We emphasize the numerator and ignore,
if we even know, the denominator.
In March, the National Association
of State Retirement Administrators
released two short but meaty reads,
the first on public pension plan investment return assumptions, the second
an analysis of the Rauh paper. Both
attempted to reassure readers that there
was a basis in fact for investment return
assumptions: Over a 20-year period,
median annualized investment returns
were 8.1 percent; over 25 years, 9.3 percent. In other words, the 8 percent return
assumptions prevalent among public
pensions weren’t fictional.
The analysis of the Rauh paper, “Are
State Public Pensions Sustainable?’’
said that the author ignored incremental
changes being made to improve the longterm sustainability of public pensions, and
that his central assumption, that states
would make contributions sufficient to
fund newly accrued or recognized benefits but no more, was unsupported by
current practice.
There was, it appeared, another side of
the story. How many Internet commenters
read it, I have no idea. Who cared about
the facts when alarm and exaggeration
could be echoed and amplified?
BloomBerg
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11.25.14 www.bloombergbriefs.com
Bloomberg Brief | Muni Meltdown 15
BLOOMBERG RANKINGS
Most Underfunded Pension Plans: States
RANK
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
20
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
49
STATE
Illinois
Kentucky
Connecticut
Alaska
Kansas
New Hampshire
Mississippi
Louisiana
Hawaii
Massachusetts
North Dakota
Rhode Island
Michigan
Colorado
West Virginia
Pennsylvania
New Jersey
Indiana
Maryland
South Carolina
Virginia
Alabama
Oklahoma
New Mexico
Vermont
Nevada
Ohio
Montana
Arizona
Arkansas
Minnesota
Utah
Missouri
California
Wyoming
Nebraska
Maine
Texas
Georgia
Iowa
Florida
Idaho
New York
Delaware
Oregon
Tennessee
Washington
North Carolina
South Dakota
Wisconsin
Median
FUNDING
RATIO 2013
%
39.3
44.2
49.1
54.7
56.4
56.7
57.6
58.1
60.0
60.8
61.0
61.1
61.3
61.5
63.2
64.0
64.5
64.8
65.3
65.4
65.4
66.2
66.5
66.7
69.2
69.3
71.9
73.3
74.1
74.5
74.7
76.5
76.6
76.9
78.7
79.2
79.6
80.4
80.6
80.7
80.8
85.5
87.3
88.2
90.7
91.5
95.1
95.4
99.9
99.9
69.3
FUNDING
RATIO 2012
%
40.4
46.8
49.1
59.2
59.2
56.2
57.9
55.9
59.2
65.3
63.5
62.1
65.0
63.2
64.2
65.6
67.5
61.0
64.2
67.9
69.5
66.9
64.9
63.1
70.2
71.0
65.1
63.9
74.5
71.4
75.0
78.3
78.0
77.4
79.6
78.2
79.1
82.0
82.5
79.5
81.6
84.9
90.5
88.3
82.0
91.5
93.7
95.3
92.6
99.9
68.7
FUNDING
RATIO 2011
%
43.4
50.5
55.1
59.5
62.2
57.5
62.1
56.2
59.4
71.4
68.8
62.3
71.5
61.2
58.0
71.7
68.1
64.7
64.5
66.5
72.0
70.1
66.7
67.0
72.5
70.1
67.8
66.3
73.2
72.5
78.4
82.8
81.9
78.4
83.0
81.9
80.2
82.9
84.7
79.5
82.3
90.2
94.3
90.7
86.9
89.9
94.9
96.3
96.3
99.9
71.6
FUNDING
RATIO 2010
&
45.4
54.3
53.4
60.9
63.7
58.7
64.0
55.9
61.4
68.7
72.1
61.8
78.8
66.1
56.0
77.8
66.0
66.5
63.9
68.7
79.7
73.9
55.9
72.4
74.6
70.5
67.2
70.0
77.0
74.8
79.8
85.7
77.0
80.7
85.9
83.8
70.4
83.3
87.1
81.0
83.7
78.6
101.5
92.0
85.8
89.9
92.2
96.8
96.1
99.8
74.3
FUNDING
RATIO 2009
%
50.6
58.2
61.6
75.7
58.8
58.5
67.3
60.0
64.6
63.8
83.4
64.3
83.6
70.0
63.7
85.5
71.3
72.3
64.9
70.1
83.5
75.1
57.4
76.2
72.8
72.4
66.8
74.3
79.9
77.5
77.1
84.1
79.4
86.6
88.8
87.9
72.6
84.1
91.6
80.9
84.1
73.9
107.4
94.4
80.2
95.1
93.9
99.3
91.7
99.8
75.9
FUNDING
RATIO 2008
%
54.3
63.8
61.6
74.1
70.8
68.0
72.8
69.6
68.8
80.5
87.0
59.7
88.3
69.8
67.6
86.9
76.0
69.8
77.7
71.1
81.8
79.4
60.7
82.8
87.8
76.2
86.0
83.4
80.8
87.2
81.4
100.8
82.9
87.6
79.3
92.0
79.7
90.7
94.6
88.7
101.7
93.2
105.9
98.3
112.2
95.1
92.9
103.4
97.4
99.7
82.3
MEDIAN
%
44.4
52.4
54.3
60.2
60.7
58.0
63.1
57.2
60.7
67.0
70.5
62.0
75.2
64.7
63.5
74.7
67.8
65.7
64.7
68.3
75.9
72.0
62.8
69.7
72.7
70.8
67.5
71.7
75.7
74.6
77.7
83.4
78.7
79.5
81.3
82.8
79.3
83.1
85.9
80.8
83.0
85.2
97.9
91.3
86.4
91.5
93.8
96.3
96.2
99.9
73.0
For the fourth year in a row,
Illinois, Kentucky and Connecticut top the list of most
underfunded pension plans
METHODOLOGY:
Bloomberg ranked U.S.
states based on their pension
funding ratios in 2013. The
Bloomberg municipal data and
municipal fundamentals teams
collected and supplemented
data from each state’s Comprehensive Annual Financial
Report, a set of government
financial statements. Data are
for individual states’ respective
fiscal year-ends as of the date
of publication of the CAFR.
Supplemental pension reports
intended to augment a particular year’s CAFR were added
to that year’s fundamentals.
Fiscal year-end of supplemental pension reports may
differ from the state’s CAFR.
All other reports were carried
forward to the next fiscal year.
The funding ratio provides
an indication of the financial
resources available to meet
current and future pension
obligations. Percentages were
calculated by dividing the actuarial value of plan assets by
the projected benefit obligation. Where specific data were
missing in the consolidated
reported totals, the pension
funds were contacted directly.
The District of Columbia
had a funding ratio of 103.6%
in 2013.
Source: Bloomberg
AS OF: October 2, 2014
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Bloomberg Brief | Muni Meltdown 16
VIII: Media Frenzy
Source: Svein Erik Dahl/John Wiley & Sons
Christopher Whalen
It wasn’t long before it
seemed like everyone
was talking about a Muni
Meltdown. The following is a by
no means exhaustive list of some of the
alarming stuff published on munis in 2010.
I’m not including the bloggers who at this
point were advocating defaulting on bonds
on behalf of “the taxpayers’’ or “clickbait’’
compilations like “The 10 Cities That Will
NEVER Come Back’’ that were such a
favorite of Business Insider at the time. I
should note here that Joe Weisenthal,
then of Business Insider, now works for
Bloomberg as Digital Content Officer.
Consider this, from the newspaper of record:
“California, New York and other states are
showing many of the same signs of debt overload that recently took Greece to the brink
— budgets that will not balance, accounting
that masks debt, the use of derivatives to plug
holes and armies of retired public workers
who are counting on benefits that are proving
harder and harder to pay.’’
Greek Myths
The story appeared on Page One of the
March 30 New York Times, headlined,
“State Debt Woes Grow Too Big to Camouflage.’’ Reporter Mary Williams Walsh
continued, “Some economists fear the
states have a potentially bigger problem
than their recession-induced budget woes.
If investors become reluctant to buy the
states’ debt, the result could be a credit
squeeze, not entirely different from the
financial markets in Europe, where markets were reluctant to refinance billions in
Greek debt.’’
Then there was the April blog posting by
Rick Bookstaber, a senior policy adviser
at the SEC. The next big crisis was the
municipal market, he wrote. The culprit:
overleverage, “in the form of high pension
benefits and post-retirement health care.’’
He observed: “Once a few municipalities
default, there is a risk of a widespread
cascade in defaults because the opprobrium will be lessened, all the more so if the
defaults are spurred by a taxpayer revolt —
democracy at work.’’
Bookstaber was among those asked by
Brian Chappatta at the end of 2011 about
what happened. His response is contained
in Appendix 2. I chatted with Bookstaber,
who now works for the U.S. Treasury in
the Office of Financial Research, in midNovember, and he told me he had nothing
to do with the muni market, and declined
further comment.
I knew we had reached an entirely different level of muni crisis coverage when
Matt Taibbi of Rolling Stone, who had
achieved a certain notoriety in 2009 when
he likened Goldman Sachs to “a giant
vampire squid wrapped around the face
of humanity,’’ weighed in with an article
entitled “Looting Main Street’’ in the April
15 edition of the magazine.
The Taibbi piece concerned Jefferson
County, Alabama’s use of interest-rate
swaps, and was subtitled, “How the nation’s biggest banks are ripping off American cities with the same predatory deals
that brought down Greece.’’ The message
was that municipalities were “now reeling
under the weight of similarly elaborate and
ill-advised swaps,’’ which the author termed
a “financial time bomb.’’
It had been quite a few years since I had
read Rolling Stone. I’ve been pretty exercised about municipalities’ use of swaps,
myself. I’m not sure how many Americans
get their investing advice from Rolling
Stone, but they couldn’t have found comfort
in yet another tale of predatory Wall Street
and feckless or corrupt public officials.
The right-leaning Manhattan Institute’s
Nicole Gelinas in the think-tank’s City
Journal advised readers of the Spring 2010
issue to “Beware the Muni-Bond Bubble.’’
Gelinas wrote: “Investors in municipal
bonds don’t have to worry about a thing,
the thinking goes, because the states and
cities that issue them will do anything to
avoid reneging on their obligations — and
even if they fail, surely Washington will step
in and save investors from big losses.’’
She continued: “These are dangerous
assumptions. Just as with mortgages, the
very fact that investors place unlimited faith
in a market could eventually destroy that
market. If investors believe that they take
no risk, they will lend states and cities far
too much — so much that these borrowers won’t be able to repay their obligations
while maintaining a reasonable level of
public services. The investors, then, could
help bankrupt state and local governments
— and take massive losses in the process.’’
Interesting Point of View
This was, I thought, an interesting point
of view. And then: “The uncomfortable truth
is that as municipal debt grows, the risk
mounts that someday it will be politically,
economically, and financially worthwhile for
borrowers to escape it,’’ Gelinas wrote.
Four years on, I asked Gelinas about the
relative resilience of the market. In an email dated Nov. 16, she replied, “The ‘resilency’ is shallow. Pension funds are doing
well because [of] the Fed’s extraordinary
actions to push up asset prices. But
around the nation, from state-level credits
such as Illinois and New Jersey to rich
cities like New York to poorer and smaller
cities and towns all over the place, many
places are still pretty much insolvent,’’
she wrote. “They cannot make good on
the healthcare promises they have made
to current and future retirees, and many
will not be able to make good on their
promises to pensioners. In the meanwhile,
infrastructure deteriorates because money
that should be going to the future is going
to the past. The 2009 recovery act was a
missed opportunity to help states, cities,
and other municipal credits fix their longterm structural problems, mostly pensions
and health promises, in return for immedicontinued on next page...
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ate cash; instead, Washington treated it as
a cyclical revenue shortfall.’’
She continued, “That we haven’t seen
bondholder panic is more a sign of the
desperation for yield and the principalagent problem (do retail investors really
know the risks that they are taking or do
they see bonds as ‘safe’). It’s harder today
than it was five years ago to assess the
“too-big-to-fail risk” — that is, it is unclear
whether Washington would step in to
save, say, Citigroup bondholders, this time
around, and it is similarly unclear whether
Washington would step in to save, say,
Illinois or New Jersey bondholders or pensioners. In the end, the clearest action that
Congress takes may — or may not — be in
not bailing out Puerto Rican bondholders. ‘‘
Warren Buffett opined on the muni
market at least twice in 2010, telling
shareholders at the Berkshire Hathaway
annual meeting in May, “It would be hard
in the end for the federal government to
turn away a state having extreme financial
difficulty when they’ve gone to General
Motors and other entities and saved them.’’
In June, Buffett appeared before the U.S.
Financial Crisis Inquiry Commission and
predicted a “terrible problem’’ for municipal
bonds “and then the question becomes will
the federal government help.’’
Buffett hasn’t moderated in his views. In
the Feb. 28, 2014 letter to Berkshire shreholders, he wrote: “Local and state financial
problems are accelerating, in large part
because public entities promised pensions
they couldn’t afford. Citizens and public
officials typically under-appreciated the
gigantic financial tapeworm that was born
when promises were made that conflicted
with a willingness to fund them.’’
On June 14 of 2010, Ianthe Jeanne
Dugan wrote in the Wall Street Journal
that investors were “ignoring warning signs’’
in the municipal market. The article was
headlined, “Investors Looking Past Red
Flags in Muni Market.’’
James Grant — a friend, for whom
I worked from 1994 to 1999 — offered
another take on repudiation in the June
25 Grant’s Interest Rate Observer, in a
scholarly article headlined, “Concerning
the American Repudiation Gene.’’
“So low are yields, so complacent are
investors, so persistent are fiscal deficits,
so heavy is the weight of post-retirement
employee benefits and so ill-equipped
are mutual funds to deal with anything
resembling a shareholders’ run that we are
prepared to take the analytical leap. On the
length and breadth of the muni market, we
declare ourselves bearish,’’ wrote Grant.
“The repudiation gene is ever present,’’
Grant continued, well into a very scholarly
article. “The question is whether circumstances in the tax-exempt market may coax
it out of latency and back into action.’’
I asked Jim about his call this year. On
Nov. 17, he e-mailed: “A swing and a miss.
Source: Bloomberg/Ramin Talaie
‘American Repudiation Gene’: James Grant
The muni market has continued to mosey,
there was no run on mutual funds. Perhaps
more to the point, there turned out to be
no homogeneous market on which to be
comprehensively bearish. What’s Paul
Isaac’s line?’’
Grant continued: “As to surprises: Where
we erred was in expecting surprises. The
muni market has not surprised. No drama,
no short-selling, no credit upheaval, no
volatility to speak of.’’ He concluded: “As to
the current Grant’s stance toward munis,
we judge that yields are too low. In that
they resemble yields nearly everywhere.’’
‘A Muni-Bond Bomb’
On Aug. 23, Steve Malanga of the
Manhattan Institute wrote an OpEd piece
in the Wall Street Journal about the SEC
charging the state of New Jersey with fraud
for misleading investors; the article was
entitled, “How States Hide Their Budget
Deficits,’’ and implied that other states may
be guilty of the same thing.
Malanga also had a story in the Summer 2010 edition of City Journal, “How
to Dismantle a Muni-Bond Bomb.’’ He
wrote: “State and local borrowing, once
thought of as a way to finance essential
infrastructure, has mutated into a source of
constant abuse. Like homeowners before
the housing bubble burst, states and cities
have gorged on debt, extended repayment
times, and used devious means to avoid
limits on borrowing — all in order to finance
risky projects and kick fiscal problems
down the road.’’
He offered a handful of reforms, and said
if the state and local debt bomb “can’t be
defused, we’re all at risk.’’
I chatted with Malanga about the lack
of a muni explosion since then in midNovember of this year. He noted that
rating companies were now putting much
more weight to pension debt in assessing credit, and, “What we’re seeing is a
little more skepticism in the marketplace
because of what happened in Detroit.’’ He
added, “It’s a very uncertain time’’ for the
municipal market.
In September, Meredith Whitney produced “The Tragedy of the Commons,’’ a
report on the 15 largest states. This would
have gotten a lot splashier coverage when it
appeared had Whitney actually published it.
As it was, she sent out a press release,
but refused to show it to anyone but clients.
I asked for a copy and was told I’d have to
pay for it.
Seeking Refuge
Whitney at the time said she had spent
two years working on the report, which
didn’t predict any state defaults. Yet she
began making the rounds, appearing on
business radio and television and warning
about how overleveraged states were, and
how they needed a federal bailout. In the
Nov. 3, 2010 Wall Street Journal, she wrote
an OpEd piece entitled, “State Bailouts?
They’ve Already Begun.’’
On Oct. 5, the New York Times’s Mary
Williams Walsh wrote about how Harriscontinued on next page...
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Bloomberg Brief | Muni Meltdown 18
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State and local borrowing,
“
once thought of as a way to finance
essential infrastructure, has mutated into
a source of constant abuse.
”
— Steven Malanga, the Manhattan Institute
burg, Pennsylvania, was seeking to enter
the state’s Act 47 distressed-cities program, in a story headlined “Cities in Debt
Turn to States, Adding Strain.’’ She wrote
“Across the country, a growing number of
towns, cities and other local governments
are seeking refuge in similar havens that
many states provide as alternative to federal bankruptcy court.’’
The Wall Street Journal led its Money
and Investing section on Oct. 10 with
“New Risks Emerge in Munis: Debtholders
Are Left Steamed as Some Cities Forgo
Repayment Promises.’’ The story detailed
Menasha, Wisconsin’s, failure to make
an appropriation to pay debt service on a
failed steam plant.
CALIFORNIA WILL DEFAULT ON ITS
DEBT screamed the Business Insider
headline on a Nov. 16, 2010, story about
bank analyst Chris Whalen’s appearance
on TechTicker. Henry Blodget wrote: “He
says there’s no bailout coming for California — or, for that matter, any of the other
bankrupt states. And that means big losses
for muni-bond holders ...”
On the Brink
Nicole Gelinas offered a prescription for
Congress to aid states, in a Nov. 17 New
York Post piece, “States on the Brink.’’ In
it she quoted Felix Rohatyn, the banker
who helped craft New York City’s rescue in 1975, who earlier that month told
Charlie Rose, “We are facing bankruptcy
on the part of practically every state and
local government.’’ Even Gelinas thought
Rohatyn “overstates the case today.’’ She
advised Washington to get ready to bail
out states: municipal market turmoil could
“prove contagious.’’
The Weekly Standard’s cover story on
Nov. 29 was “Give States a Way to Go
Bankrupt,’’ by University of Pennsylvania
law professor David Skeel. He suggested
that both California and Illinois might avail
themselves of such a law.
Skeel didn’t return a call for comment.
His views on Chapter 9 municipal bankruptcy seem not to have changed at all. In
August, he wrote a piece for the Wall Street
Journal, approving Puerto Rico’s new law
allowing certain public corporations to
restructure their debt. “If Puerto Rico can
restructure its debt,’’ he wrote, “there could
be hope for states — particularly Illinois
— whose own finances are sketchy.’’ He
continues to advocate a federal bankruptcy
law covering the states.
The lead story in the Dec. 5 Sunday New
York Times was “Mounting Debts by States
Stoke Fears of Crisis’’ by Mary Williams
Walsh. And on Dec. 7, then-Business
Insider’s Joe Weisenthal wrote about a
Facebook post by Sarah Palin: “Sarah
Palin Knows Where The Next Battle Is, As
She Blasts The Idea of Bailing Out States.’’
Palin wrote: “American taxpayers should
not be expected to bail out wasteful state
governments. Fiscally liberal states spent
years running away from the hard decisions that could have put their finances on
a more solid footing.’’
Now, you might well ask what kind of stories Bloomberg News was running at this
time. Among the stories filed by the States
& Municipalities team were “Moody’s
Muni Bond Ratings Will Move to Global
Scale,’’ “U.S. States Expect Taxes to Rise
After Facing $84 Billion Gaps,’’ and “Wall
Street Takes $4 Billion From Taxpayers as
Swaps Backfire,’’ this last an investigative
piece quantifying how much in swap termination fees municipal issuers had paid to
banks since 2008.
And then on Sunday evening, Dec. 19,
“60 Minutes’’ ran a segment entitled “State
Budgets: The Day of Reckoning.’’
REAL ESTATE
THIRD QUARTER 2014
CLICK HERE
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Bloomberg Brief | Muni Meltdown 19
IX: The Market Responds to Its Critics
Before we turn to the events of Sunday,
December 19, a day that will live in municipal market infamy, let’s briefly consider
some of the stuff that was published and
subsequently rattled around on the Internet, and the market’s response to it.
The articles that appeared in 2010 were
generally long on headline, short on
specifics.
They shared a common theme: Something terrible is going to happen. And that
is: States and municipalities are going to
default on their bonds, because they are
all being overwhelmed by debt and pension obligations.
Most of the stories contained no fine
shading, no nuance, and, unless the
various articles described exceptional incidents that were already well-known and
previously-reported — Harrisburg, Jefferson County, the Menasha, Wisconsin
steam plant, Vallejo’s bankruptcy, various
silly economic development, stadium and
convention center financings — there was
very little that was new. Beyond this rather
large generalization: California, Illinois
and New York, staggering along under
seeming mountains of debt, are all going
to go bust.
Missing Detroit
I suppose if you had wanted to look at
things “nobody was talking about’’ back
then, nobody was talking about Detroit
staggering along toward an eventual
bankrutpcy filing in 2013, or that Puerto
Rico had its own crushing mountains of
debt, or that Jefferson County, Alabama,
would file for bankruptcy in 2011 or that
Stockton, California, would file in 2012.
That would have all been very useful, but
it also would have required a lot of digging
and a ton of luck. Along with predicting
that Michigan Governor Rick Snyder
would specifically authorize Detroit to file
for Chapter 9.
The articles that appeared in 2010
almost all seemed intent on proving “the
market’’ wrong, but only by way of innuendo. Most of the authors were confounded by the lack of movement in what they
called “prices,’’ although what they usually
referred to was one or another of various
yield indexes rather than actual trading.
That’s because most bonds only trade
Tom Kozlik
for the first 30 days after being sold. So
when someone writes, for example, “the
municipal market tanked,’’ I want to ask:
How do you know? That’s an equity mindset. What really happens is: The bid-side
dried up. It’s not as though you can go
someplace and say, “Okay, I’d like to buy all
the cheap munis now.’’
Finally, some of the provocative material
that was published in 2010 was frankly
political, aimed at public-employee labor
unions, now fingered as the culprits
behind massive state and local pension
liabilities. Their 401(k) accounts and retirement dreams now in shambles, many
Americans were prepared to indulge in
pension-envy.
The municipal bond industry reacted
slowly and thoughtfully to the hysteria. By
the fall of the year, though, the industry
had produced a number of solid, comprehensible reports spelling out, basically,
That’s Not How This Market Works.
One of the first responders was Tom
Kozlik, a municipal credit analyst at Janney Montgomery Scott in Philadelphia.
In the firm’s July 14, 2010, Municipal Bond
Market Monthly, Kozlik wrote, “Many stories published of late in the popular press
have included overblown perspectives of
municipal market risk.’’
His piece was entitled, “Municipal
Market ‘Myths’ and ‘Truths’ and ‘Veritas
Vos Liberabit’ Which Means, ‘The Truth
Shall Set You Free.’ ’’ He discussed
headline risk, and observed, “Although
recent articles in the popular press try
to portray a balanced opinion about the
status of the municipal market, too often
writers and commentators are not relying
on municipal market experts for facts
about the realities stressing the municipal
market.’’ He continued, “The confusion,
lack of knowledge and resulting fear
mongering we have seen in the print and
televised media has occurred because
continued on next page...
The confusion, lack of knowledge and
“resulting
fear mongering we have seen in
the print and televised media has occurred
because of the media’s misunderstanding of
the municipal market.
”
– Tom Kozlik, municipal credit analyst at Janney Montgomery Scott
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got through and was disregarded because
it didn’t fit the narrative, or was dismissed
because the writers felt the analysts involved were somehow discredited.
So much of what I thought passed for
“dialogue’’ in those days was, after all,
privately disseminated. Reporters only
received some of it.
People Unfamiliar
Source: Bloomberg/Jin Lee
“Tragedy of the Commons”: Meredith Whitney
of the media’s misunderstanding of the
municipal market.’’
The myths Kozlik addressed: That there
was going to be a “‘Municipal Meltdown’
or a percentage of defaults or municipal
bankruptcies’’ significantly above the historical norm; that the market would crash
like the sub-prime loan market; that there
would somehow be a default or bankruptcy “contagion effect;’’ that California,
Illinois, or New Jersey would be “the next
Greece;’’ that ratings and bond insurance
were worthless.
I’m not sure how many reporters or commentators saw Kozlik’s piece, or the various other rejoinders that started to appear
thereafter. Maybe some of this material
As Kozlik wrote in a retrospective piece
on Aug. 27 of this year, “Several reporters were dead set on the idea that the
municipal market was the next sub-prime
market and the municipal market would
melt-down.’’
Most of the stories stoking the hysteria about munis featured quotes by, as
I would characterize them now, people
unfamiliar.
The go-to guy for the insider’s point of
view, someone who actually knew what
he was talking about and wasn’t afraid
of being quoted, was Matt Fabian of the
research firm Municipal Market Advisors. He was the Voice of Reason, the To
Be Sure source in a sea of inexpert testimony. He must have been a very busy
man. In some ways, I performed a similar
role briefly in 1995, after Orange County,
California, went bust. You can look it up.
On Sept. 30, 2010, Fabian produced a
one-sheet “Special Report on Vilifying
State Creditworthiness,’’ a sort-of response to Meredith Whitney’s “Tragedy
of the Commons,’’ which he admitted he
had not seen yet. After acknowledging the
report might have some salutary effect in
regard to budget-cutting, pension-building,
debt-deferral and increased disclosure,
Fabian wrote: “We are reluctant to directly
rebut the report without having the docu-
Most U.S. states are lightly indebted
“compared
with regional governments
elsewhere in the world.
”
— Gabriel Petek, Standard & Poor’s
ment itself. However, based on media coverage, it appears to succumb to what has
been a common problem of non-municipal
observers of our market: the conflation of
various state stakeholder exposures.’’
Misunderstood Leverage
States are unlikely to default on their
bonded debt, he said, because of a number of legal protections. What meltdown
proponents were predicting was a mass,
anarchic, political and legal abdication.
He also addressed “rollover risk,’’ first
broached by Frederick Sheehan the
previous year in his “Dark Vision.’’ Remember, wrote Fabian, “that ‘leverage’ is
an often misunderstood term. While states
have greatly increased debt borrowings
over the last five years, essentially all
outstanding municipal debt is self-amortizing. Meaning, similar to a residential
mortgage, principal is paid down regularly
via level annual debt service payments
funded with tax receipts. ‘‘
He continued: “Municipal issuers do not
borrow as do international sovereigns or
the US treasury: via large short maturity
notes that in practice can only be refinanced with more debt, creating a crippling reliance on market acceptance for
solvency. As we saw in 4Q08, an extended primary market ‘closure’ produced no
knock-on defaults; states simply stopped
funding new infrastructure until rates fell
far enough to justify the cost.’’
John Hallacy, head of municipal
research at the then-new combination,
Bank of America Merrill Lynch, confronted “Apocalypse Muni’’ in a comment
piece on Oct. 1. He acknowledged that
the federal government had already assisted the states: “The ARRA or stimulus
provided several different levels of assistance including extending Unemployment
Insurance benefits. Additional legislation
in the amount of $26 billion was approved
to provide extension of a higher level of
Medicaid reimbursements for two quarters
in the amount of $16 billion, and additional education assistance with the remaining $10 billion.’’
Hallacy also noted, “Debt and the
amount of leverage on the part of the
issuer have never been the best predictors of creditworthiness,’’ and observed:
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“The ratio that matters the most to us
is the debt service carry on the budget.
Most issuers keep this ratio well within 10
percent, and the level is typically closer
to 5 percent. If the debt service carry is
over 10 percent, the reason is most often
because said issuer prefers to amortize its
debt on a more rapid schedule.’’
So maligned had the asset class become by this time that Hallacy added at
the end of his piece, “We are not apologists for the Municipal Market.’’ Moody’s on Oct. 5 published a Special
Comment, “Why US States Are Better
Credit Risks Than Almost All US Corporates.’’ The Comment described Illinois, at
the time the lowest-rated state at A1, and
then detailed why all of the states, even
Illinois, were of better credit quality than
96 percent of corporate borrowers.
Munis Not Corporates
Fundamental strengths of states, according to Moody’s, include the capacity
to increase revenue by taxes; the ability to
cut expenses and capital outlays without
reducing revenue; strong legal protection
for debt service payments; limited consequences to running deficits and accumulating negative balances; less competitive
pressure; lower event risk; and potential
federal support.
This was probably one of the more
important pieces produced during the
crisis, describing as it did the unique characteristics of states (and, by extension,
municipalities) compared to companies.
People unfamiliar have long confused the
equity and municipal markets, in the way
they trade and in the way they respond
to bad news. It is little wonder, then, that
they also likened municipal issuers to
companies. In fact, as Moody’s pointed
out, “Game Over’’ looms over companies
much more closely than it does over
states and municipalities.
On Nov. 8, Gabriel Petek of Standard &
Poor’s published two reports: “U.S. States’
Financial Health and Debt Compare
Favorably With Other Regions’’ and “U.S.
States and Municipalities Face Crises
More of Policy Than Debt.’’
In the first, S&P reminded readers that,
“From a global perspective, most U.S.
states are lightly indebted compared with
regional governments elsewhere in the
world. In our opinion, various constitutional or legal requirements for balanced
budgets — more unusual outside the U.S.
— have kept U.S. states’ debt burdens at
moderate levels.’’
The report compared Ontario, Bavaria,
Basel, Texas, New York, Illinois and
California, and concluded, “in our assessment of U.S. states’ creditworthiness, we
consider debt service payments to be a
very modest proportion of expenditures
and admit that most administrators are
able to manage through severe economic
turbulence, due in part to their relative
lack of leverage. We believe that some
discussions about financial catastrophe
are meaningful only if governments prove
unwilling to use their powers of adjustment to manage their positions.’’
Economic Engines
The analysis included a table of various
financial measures and showed how states
stacked up — pretty favorably, especially in
terms of revenue. California and New York
in particular are economic engines.
The larger piece emphasized state and
local government agency. That is, these
governments have the ability to manage their way out of financial crises, and
Standard & Poor’s expected them to do
so: “We believe the crises that many state
and local administrators find themselves
in are policy crises rather than questions
of governments’ continued ability to exist
and function. They’re more about tough
decisions than potential defaults.’’
The report stated that debt service is
usually a payment priority, a legal obligation, and then considered California,
Illinois, New York and Texas, as well as a
number of localities, including Las Vegas
and Detroit.
From our perspective today, perhaps
Detroit is the most interesting of the
bunch. The rating company was unequivocal: “Michigan has repeatedly indicated
to Standard & Poor’s that it would take all
steps necessary to prevent a[n emergency financial] manager from filing for
bankruptcy protection.’’
Fitch offered a Frequently Asked Ques-
Source: Bloomberg/Jennifer S. Altman
‘Bold prediction! Don’t back down now!’:
Henry Blodget
tions written by lead analyst Richard
Raphael called “U.S. State and Local
Government Bond Credit Quality: More
Sparks Than Fire’’ on Nov. 16. I liked it
because it was full of common sense and
treated the subject in straight English, and
reiterated the strengths of the market:
“Due to the 20- to 30-year principal
amortization of debt that is common in
the U.S. municipal market, large bullet
maturities and consequent refinancing
risk is limited,’’ and “Debt service is a relatively small part of most budgets, so not
paying it does not do much to solve fiscal
problems (particularly as compared to the
costs of such an action),’’ for example.
And then the company treated “systemic
risk,’’ or the chance that the entire market
would melt down somehow: “The municipal bond market is diverse, with thousands of issuers, over a dozen distinct
sectors, and multiple security structures.
The legal framework for municipal bonds
depends upon a multitude of constitutional, statutory, local ordinance, and contractual provisions. Each municipal bond
sector has unique criteria and risks. Further, in many cases, a single municipality
will issue several series of bonds, each
secured by a different type of security.’’
I think the two pieces I enjoyed most
emanated not from the industry but
from the media itself. On Nov. 22, Brett
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Bloomberg Brief | Muni Meltdown 22
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Arends of MarketWatch responded to
the Christopher Whalen “California Will
Default’’ interview with Henry Blodget the
previous week.
“Can everyone please stop talking total
nonsense about the California budget?’’
wrote Arends. “I know that facts and truth
seem to be optional these days. I know that
in the exciting new world of infinite media
everyone can choose to believe whatever
fantasies they want. But in the case of
California, it’s getting on my nerves.’’
Arends recounted an e-mail exchange
he had with Whalen, who said “My general comments have to do with my guess
as to the impact of mounting foreclosures
and flat to down GDP on state revenues.’’
‘All Henry’s Fault’
Arends replied, “Your guess? These are
important problems, to be sure. But do
you have any actual numbers?’’ To which
Whalen replied, “Revenues fall and mandates rise to the sky. You do the math.’’
Arends pressed: “Er, no, actually, it’s your
assertion. You do the math.’’ Whalen finally
blamed Blodget. “I am a bank analyst. I
have not written anything on this. My comments have taken on a life all their own.
This is all Henry’s fault. Call him.’’
“Some prediction,’’ Arends wrote, and
then: “Meanwhile Blodget chimed in on
the e-mail exchange: ‘It’s a bold predic-
tion! Don’t back down now!’ ‘’ Arends
concluded: “Bah. Welcome to the media
world in 2010.’’
He then produced a piece showing that
California, far from being the Greece of
America, was actually the Germany of
America, an economic powerhouse with
a high standard of living, where entrepreneurs still wanted to do business and one
of the states that sent far more money to
Washington than Washington redistributed.
It didn’t end there. On Nov. 23, Felix
Salmon wrote about the incident for the
Columbia Journalism Review’s “The Audit’’
blog, which discusses financial journalism:
“In reality, what we’re seeing here is expertise mission creep, and a rare example
of an expert admitting to it. Whalen’s company is highly regarded when it comes to
analyzing banks’ balance sheets, and as
a consequence of that regard, Whalen
has gotten for himself a nice perch in the
punditosphere, as well as a new book. But
Whalen, as he admitted to Arends, is no
more an expert on municipal finance than
Freeman Dyson is on global warming. And
so the proper stance for Blodget to take
was not to deferentially pose questions
to Whalen and then passively receive
his oracular words of wisdom, but rather
to push back and have a proper debate
about Whalen’s assertions, as Arends
might have done.’’
This was the clincher for me, though:
“More generally, the municipal bond
market is a very complicated place, where
expertise is hard-earned and voluble
new entrants are inherently mistrusted,
normally for good reasons.’’
Whalen, now a Senior Managing Director at Kroll Bond Rating Agency,was one
of those interviewed by Brian Chappatta
at the end of 2011 about the lack (so far)
of a Muni Meltdown, and his comments
lead off Appendix 2. I also e-mailed him
on a recent Sunday to ask him about it.
On Nov. 16, he e-mailed: “The process
has proceeded about as I thought. Cases
like Detroit and Stockton, CA, are the
extreme examples where default has occurred, but in general the political class
has proven able to extend and pretend
with respect to sovereign credits of varying sizes. Puerto Rico is another case
where the threat of a general default is
being used to forcibly restructure debt. In
the case of GM, which was a sovereign
credit for a time, the fact of default was
used to ride over investors’ rights. Indeed,
GM may well end up back in bankruptcy
because of unresolved pension liabilities
and chronic operational problems. CA was
saved, for now, by Governor Brown, who
is not afraid to say no to both parties in
the CA assembly.’’
Which brings us to “60 Minutes’’ and its
segment “Day of Reckoning.’’
FOLLOW TAYLOR RIGGS ON TWITTER FOR
REGULAR UPDATES AND ADDITIONAL INSIGHTS
>>>
@TaylorRiggsMuni
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Bloomberg Brief | Muni Meltdown 23
X: Oh, Meredith
“Hundreds of billions.’’
With these three words,
analyst Meredith Whitney
won fame and notoriety
and, eventually, ignominy.
The payoff: Prominent mention in scores
of newspaper, magazine and blog articles,
dozens of appearances on business radio
and television and of course (in February of
2012) the inevitable book contract.
The phrase came almost at the end of a
“60 Minutes’’ episode entitled “State Budgets: The Day of Reckoning,’’ an otherwise
unremarkable and succinct look at public
finance by CBS correspondent Steve
Kroft, which aired on Dec. 19.
Whitney appeared at the end of the
segment, in the role of Expert on the Municipal Bond Market. She was, said Kroft,
convinced that some cities and counties
wouldn’t be able to meet their obligations
to bondholders. She said there would be
a “spate’’ of defaults. Asked to define a
spate, she replied, “50 sizeable defaults.
Fifty to 100 sizeable defaults. This will
amount to hundreds of billions of dollars’
worth of defaults.’’
Patted on the Head
Kroft observed that Moody’s and Standard & Poor’s, “who got everything wrong
in the housing collapse’’ said there was
“no cause for concern.’’ Whitney, who, we
were reminded by Kroft, had spent (with
her staff) “two years and thousands of
man hours trying to analyze the financial
condition of the 15 largest states,’’ wasn’t
buying it: “When individual investors look
to people that are supposed to know
better, they’re patted on the head and
told, ‘It’s not something you need to worry
about.’ It’ll be something to worry about
within the next 12 months.’’
Then Kroft said, “No one is talking about
it now, but the big test will come this
spring. That’s when $160 billion in federal
stimulus money, that has helped state and
local governments limp through the great
recession, will run out. The states are
going to need some more cash and will
almost certainly ask for another bailout.
Only this time there are no guarantees
that Washington will ride to the rescue.’’
Cue the stopwatch.
“Hundreds of billions’’ was the key
takeaway from this segment. Municipalities would default on hundreds of billions
of dollars in bonded debt, and within the
next 12 months, or at least starting within
the next 12 months. Everything else in the
segment, you could say, yeah, everyone knows that, everyone knows that,
everyone knows that, until you struck the
“hundreds of billions’’ line, and, well, not
everyone knows that.
Bold call! The record year for defaults
until then was 2008, when $8.5 billion
in bonds went into actual or technical
default. And Whitney said — I went back
and listened to the entire broadcast several times, just to make sure I had heard
what I thought I’d heard — “hundreds of
billions.’’ As in, not $100 billion, but a multiple, meaning, at least $200 billion. And
this would be something to be concerned
about within the next 12 months.
Keep in mind when this “60 Minutes’’ episode aired. It was Sunday, Dec. 19. Most
of the market was either already on the
end-of-the-year holiday or looking forward
to beginning it. Most banks and rating
companies probably weren’t anticipating
putting out municipal market commentaries until January.
There are some columns you can’t wait
to write. This was one of them, for me
(see Appendix I). “Hundreds of billions’’
seemed to me to be in the realm of the
fabulous, and I said so. It made no sense
to me that a boatload of municipalities would all choose to renege on their
bonds, especially since, as Fitch and
others had pointed out just weeks before,
debt service usually makes up a small
part of their costs. Not paying debt service
wouldn’t do much to solve their fiscal problems. I also included my own prediction for
defaults in 2011: Between 100 and 200,
totaling between $5 billion and $10 billion.
I wrote the column on Monday (the
same day, Whitney appeared on CNBC); it
was edited on Tuesday, and was published later that night. It appeared on our
Page One on Wednesday.
Inexpert Witness
of billions,” MMA saying late Monday,
“Given the dire certainty presented by
Whitney, it is a wonder the US equity markets did not collapse on Monday under
the weight of the anticipated demise of
the state and local government entities.’’
On Tuesday, Kozlik put out a strategy
piece headlined, “There is Not a Looming Municipal Market Crisis, Although
Many Factors are Stressing Issuers.’’ He
advised: “Investors should not panic and
sell-off municipal holdings.’’
For the next year, and the next, and
even well into 2013, when her book, “Fate
of the States’’ was published, Meredith
Whitney was Topic #1 in the municipal
market. Never had a personality become
such a polarizing obsession. Whitney,
whose remarks were really just a punctuation mark on the “Muni Meltdown’’
hysteria, after all, came to represent all
the inexpert witnesses who had forecast
the market’s imminent demise.
To paraphrase Winston Churchill on
the Battle of El Alamein, before Meredith
Whitney, the asset class never had a win.
After Meredith Whitney, it almost never
suffered a defeat.
The terms of the debate narrowed. Now
instead of a vague “meltdown’’ forecast,
municipal bond defenders, if that is the
right word, could just point to “hundreds of
billions’’ and say, That’s not going to happen, and explain why.
I think my column was the most-read on
Bloomberg that Wednesday, and I even
got a call from our television producers
to come on and explain myself. This one
column also cast me in a new, heroic role:
Municipal market champion. E-mails of
thanks and praise came in.
This was unfamiliar ground for me. If
anything, I was regarded as a scold by
many bankers, especially for my general
opposition to the use of interest-rate
swaps by all but the most sophisticated
municipal bond issuers.
E-mails ran about four-to-one in my favor,
all of which I duly saved. The pro-Meredith
Whitney ones generally reminded me that
Whitney had called Citigroup dropping its
dividend and how dare I, a mere journalist,
declare myself a better analyst?
By then, both research firm Municipal
Market Advisors and Tom Kozlik of Janney Capital had responded to “hundreds
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Bloomberg Brief | Muni Meltdown 24
XI: After “Hundreds of Billions’’
There were lots of things for the municipal market to focus on in 2011: Bond
ratings, new regulations, the future of
tax-exemption, bid-rigging, swap termination fees, accounting rules, bankruptcies,
defaults. And it did, of course. But the
main focus was all-Meredith Whitney-allthe-time.
Oh, there were a few last gasps of generic big-media hysteria. On Jan. 21, The
New York Times led the paper with a story
headlined, “A Path Is Sought for States To
Escape Debt Burdens,’’ about how “policy
makers are working behind the scenes’’
to come up with a way to allow states to
declare bankruptcy. In fact, it seemed
that states wanted no part of access to
bankruptcy.
And in March, Nouriel Roubini presented “States of Despair,’’ which, despite
the title, was really anti-hysterical. In it,
the firm explained all the reasons why a
meltdown of apocalyptic proportions, i.e.,
“hundreds of billions,” was extremely unlikely, and observed: “Our base case sees
close to $100 billion of defaults over five
years, but typical 80 percent recoveries
are far higher than on corporate bonds.’’
Not the Titanic
More importantly, Roubini stated that it
was incorrect to “assume the Titanic is set
on autopilot heading for the North Pole.’’ In
other words, state and local governments
weren’t passive observers, and could be
expected to try and address the situation. And he called any state bankruptcy
discussions “dead on arrival.’’
The full title of the Roubini report was
“States of Despair Part 1: Muni Stress —
Past, Present and Future.’’ I’m not aware
of any Part 2 ever being published.
But the real story was Meredith Whitney.
In February, the New York Times acknowledged as much with a story, “A Seer on
Banks Raises a Furor on Bonds.’’
Redefining Default
For someone who had studied state and
local finance for at least a couple of years,
she didn’t seem familiar with the nomenclature. In 2010, she very briefly tried to
redefine “default.’’
Rather than meaning missing a debt
service payment, or violating a bond covenant, Whitney said that when she used
the word “default’’ it meant something like
breaking the “social contract’’ by reductions in spending. Using this definition,
everything from curtailing library hours
to reducing retiree health-care benefits
could be considered a “default.’’ You can
see how easily “hundreds of billions” could
add up.
But of course this was an absurdity.
Eventually, in 2011, Whitney said she
stuck by her “60 Minutes” phrase “hundreds of billions’’ of dollars in defaults,
but added that “it was never a precise
estimate over a specific period of time.’’
Yet it sure sounded that way to anyone
who watched “60 Minutes.’’
She also used the word “restructurings’’ in a corporate way. In the municipal
market, when bankers and issuers talk
about “restructuring,’’ they usually mean
refunding a deal so as to extend maturity — or at least they did until the Detroit
bankruptcy.
In the corporate world, restructuring
usually means some form of a cramdown.
Whitney hinted darkly that there were lots
Her words were being
“
misrepresented so that her message might
be more easily attacked.”
— Michael Lewis, Author, referring to Meredith Whitney
Source: Bloomberg/Simon Dawson
Anti-hysterical: Nouriel Roubini
of “restructurings’’ going on out there in
MuniLand, secretly.
Whitney also believed the Build America
Bond program that was featured as part
of the Obama fiscal recovery act represented a kind of hidden bailout to states:
“These states might have already reached
some type of tipping point had the federal
program not been in place’’ she wrote in
the Wall Street Journal.
Such was the critical opposition to
Whitney and her “hundreds of billions’’
call immediately post-”60 Minutes’’ that
journalistic bigfoot Michael Lewis eventually felt called upon to defend her, in his
August Vanity Fair magazine piece on
California, part of a series he was writing
on the financial crisis. “Her words were
being misrepresented so that her message might be more easily attacked,’’
Lewis wrote.
Well, let me stop right there. Whitney
did have a larger story to tell, but all most
people had to go on was her brief appearance on “60 Minutes’’ with its explosive
conclusion. It’s not as though the show’s
non-municipal-market-expert viewers
could be presumed to have watched all
the various cable news and business
radio episodes featuring Whitney. And on
the “60 Minutes’’ segment, the most important thing she had said was “hundreds
of billions’’ in defaults.
Whitney’s larger message was expounded in Lewis’s article, and later in her own
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Bloomberg Brief | Muni Meltdown 25
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book, “Fate of the States.’’ Boiled down,
it goes something like this: Some states
and their municipalities have borrowed
too much and promised too much to
their employees. This overleveraging will
become apparent to all as these governments are forced to cut services and raise
taxes. People and companies who can
afford to will decamp to greener pastures,
those states that haven’t borrowed too
much and that have low taxes. The new
power region of the country is going to be
the formerly flyover American heartland,
and certain states in the South and West.
In April of 2012, at a Grant’s Interest Rate
Observer conference, Whitney said this
would play out over the next two decades.
This was indeed a message, a very
plausible, reasoned theory, even if I
thought it wrong and not a little derivative.
Whitney protested to Lewis that she
didn’t care about the “stinkin’ municipal
bond market.’’ And this seemed to be very
true, although in November of 2010 she
told the Financial Times that she was
seeking approval from the SEC to set up
a credit rating firm, which would grade
municipal bonds, among other things. And
on Bloomberg radio’s “Surveillance,’’ in
May of 2012, Whitney said that she only
looked at the big picture, not the Cusipby-Cusip (and particular-and-specific)
world of munis.
Which means that the “hundreds of billions’’ call was meaningless, unless somehow also attached to a multi-generational
forecast of fundamental demographic
shift. The idea that people would vote with
their feet and flee the high-cost, high-tax
coastal states isn’t a new one.
I’m not sure that this nuanced theory
would have garnered the attention, and
subsequent book deal, and all the rest of
it, that “hundreds of billions’’ did.
Meredith Whitney didn’t respond to my
calls and e-mail for comment.
Stinkin’ Municipal Market
I’d like to say that the Muni Meltdown
hysteria died of natural causes. The
economy revived, tax collections rose,
municipal officials did their jobs, defaults
didn’t explode. That happened. I’d also like
to say that the hysteria was dispatched by
those who knew what they were talking
about returning fire with articles and blogpostings and pieces of research dense
with unassailable facts and statistics. That
also happened. And I’d like to say that the
willingness of people like David Kotok
and Dick Larkin and Alexandra Lebenthal and Matt Fabian, among many
others, to appear on business television
to explain the municipal market in slow
motion — I’d like to say that quieted the
Meltdown hysteria. Because that, too,
happened.
I suspect the real reason the Meltdown hysteria subsided was because of
Whitney. As she told Michael Lewis, she
didn’t care about the stinkin’ municipal
bond market. Yet that was all the reporters on the Muni Meltdown Hysteria beat
cared about, now that there was a specific
target: “hundreds of billions.’’
Whitney refused to engage.
Game over.
Briefs
on the
radio
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Bloomberg Brief | Muni Meltdown 26
XII: Returning Fire
Market participants began returning fire
on the meltdown proponents during the
second half of 2010. Meredith Whitney’s
“60 Minutes’’ appearance at the end of the
year quickened the pace.
In the Muni Meltdown Hysteria media
game of 2010 and 2011, the burden of
proof was always on the market. Meltdown
adherents sent screaming headlines hurtling around the web about how the entire
municipal market was going to implode,
and watch out below. Responsible analysts
eager to retain their credibility had to
respond with detailed, sometimes ponderous, explanations of why that amorphous
and incendiary possibility wasn’t the case.
Then came Whitney. As I said, it was one
thing to respond to the vague meltdown
business, quite another to say why “hundreds of billions’’ was utterly implausible.
Smackdown
Some of the best analysis was done immediately after “60 Minutes.’’ The New York
Post on Friday, Dec. 24, termed the week
post-”60 Minutes’’ a Whitney “smackdown’’
(Whitney’s husband had been a professional wrestler) and quoted Ben Thompson of Samson Capital, who appeared
on CNBC and said the “numbers just
don’t add up.’’ He said, “I can’t make the
numbers work. If you look at the 10 largest
cities and the 25 largest counties in the
country, that’s $114 billion in debt outstanding. So you gotta basically have New York,
Chicago, Phoenix, Los Angeles — these
cities start to default.’’
Source: Bloomberg/Jin Lee
Asking simple questions: Citi’s George
Friedlander
For one thing, all of the top 50-100
“
municipalities in total do not have ‘hundreds
of billions of dollars’ of debt outstanding.
”
— George Friedlander, Citi
On Dec. 21, Citigroup’s George Friedlander responded at length in the firm’s
Municipal Market Comment wihout naming
Whitney: “For one thing, all of the top
50-100 municipalities in total do not have
‘hundreds of billions of dollars’ of debt outstanding. Achieving an outcome anywhere
close to this projection would require not
just that some major local governments
would fail in the near future, but that
virtually all of them would. If such a result
were at all possible, it would be far from a
secret, suggestions that municipal market
participants — rating agencies, municipal
finance departments, dealers and portfolio
managers — are somehow ‘complacent’
notwithstanding.’’
Friedlander also paused to reflect on the
meltdown hysteria: “We note that there
has been a virtual avalanche of reports
of this type over roughly the past fourteen
months. The reports had several attributes
in common: They were written by individuals whose main expertise was in sectors
other than municipal bonds and whose
main claim for credibility was that they had
been accurate in forercasting disaster in
some other sector; They projected that
there would be a very sharp upswing in the
magnitude of defaults on rated municipal
credits in the future, over a relatively short
time period (i.e., over the next year or two);
and The projections did not appear to treat
effectively the differences between corporate credits and state and local credits.’’
Sometimes the simplest questions
are the best. How do you even get to
“hundreds of billions’’? On Jan. 4, 2011,
Michael J. Schroeder, CIO of Wasmer,
Schroeder & Co. put out a comment on the
subject, showing just how difficult it was,
once you netted out the states and bonds
that were escrowed with U.S. Treasury
securities or their equivalents.
1 in 7
If 200 “average’’ issuers defaulted, that
might add up to $10 billion, wrote Schroeder. If you took the top 20 cities, they had
about $115 billion in direct and overlapping
debt, and none of them seemed about to
go bust over the next 12 months.
Finally: “To arrive at a figure of ‘hundreds
of billions’ of par amount defaulting in the
next 12 months, by my estimate, over
5,000 issuers would have to default on
their municipal debt, or about 1 in 7 that
have debt outstanding.’’
At least two more white papers designed
to challenge the hysteria appeared. On
Jan. 20, the Center on Budget and Policy
Priorities published a 21-page white paper
entitled, “Misunderstandings Regarding
State Debt, Pensions, and Retiree Health
Costs Create Unnecessary Alarm,’’ a nice
primer that addressed every aspect of the
meltdown hysteria, although it didn’t mention Whitney by name.
And in February, the Center for Economic
and Policy Research published a paper
on “The Origin and Severity of the Public
Pension Crisis,’’ which sought to remind
everyone that the real reason so many
pension plans were underfunded was
because of the shellacking they had taken
in the stock market.
Any bibliography of bank and rating
company responses to the Muni Meltdown
Hysteria would probably run to 40 or 50
separate items. Most were distributed
privately to clients, but several managed to
surface and broaden the debate.
That is, to the extent there was any longer any debate. By the middle of the year,
it was apparent that Whitney’s “hundreds of
billions” and Munigeddon weren’t imminent.
All that remained was counting defaults
and watching the calendar, and pointing
out how silly it had all been.
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Bloomberg Brief | Muni Meltdown 27
XIII: What Happened, and Lessons Learned
160
140
Number of Defaults
“Jeffco, Detroit, Rhode Island, Puerto
Rico. Harrisburg, San Bernardino, Vallejo,
Stockton, all before getting to the usual
suspects,’’ a colleague e-mailed me. To
this I might add, the redefining of the
General Obligation bond in the wake of
the Detroit Chapter 9 bankruptcy.
Point taken. Each of them is exceptional.
Each is worth an extended piece on its own
merits. First, let’s look at what did happen.
The recession ended in June of 2009.
2010 was the year of hysteria, culminating
in Meredith Whitney’s “60 Minutes’’ prediction. In 2011, 133 issuers defaulted on
$6.56 billion in municipal bonds, according to Municipal Market Advisors.
This being the municipal market, of
course, not everyone agreed at the time
about the definition of default. Richard
Lehmann, publisher of the Distressed
Debt Securities Newsletter, put the 2011
figure at almost $26 billion, if you counted
tobacco bonds and the munis backed by
American Airlines in the total, and if you
counted both actual and technical default.
If you counted only actual payment default, the figure was $6.56 billion in 2011,
$1.94 billion in 2012 and $8.54 billion in
2013, according to MMA. The total for
2014 will likely top the 2013 total, because
of Detroit, says MMA.
Now let’s consider municipal bankruptcies. Vallejo, California, went bust in May
of 2008, pre-hysteria. Central Falls, Rhode
Island, filed for Chapter 9 in August of
2011. Harrisburg, Pennsylvania, filed in
October of 2011, but this was thrown out.
The then-record municipal bankruptcy
was filed by Jefferson County, Alabama,
in November of 2011, the proximate cause
failure by the state to allow the county to
levy a tax.
In the summer of 2012, San Bernardino,
Stockton and Mammoth Lakes, California,
all declared bankruptcy. Bloomberg News
carried a story on July 13: “Buffett Says
Muni Bankruptcies Set to Climb as Stigma
Lifts.’’ In 2012, there were a dozen Chapter
9 filings, most of them for things like sanitation and irrigation districts.
Number of Defaults Dropped . . .
140
Number of Defaults
133
Par Value (in Blns)
120
107
100
80
65
60
45
40
20
$6.56
$4.03
0
2010
2011
2012
$8.76
$8.54
$1.94
2013
2014
Source: Municipal Market Advisors
. . . Investors Withdrew Funds After Meredith Whitney Call
100
Muni Bond Flows
80
$81.1
60
In Billions of U.S. Dollars
So, the Great Municipal
Market Meltdown — that
didn’t happen.
Or did it?
$46.0
40
20
$9.4
$21.1 $17.3
$15.8
$18.1
$5.0
0
-20
-$9.9
-$14.4
-40
-60
-80
-$64.2
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Q1-Q3
Source: Lipper US Fund Flows
In July of 2013, Detroit became the new
record municipal bankrupt. Meredith
Whitney penned an opinion piece for
the Financial Times, headlined: “Detroit
Aftershocks Will Be Staggering,’’ or as
Business Insider put it in their pickup:
“Meredith Whitney: Detroit Will Start a
Wave of Municipal Bankruptcies.’’
In 2013, there were eight Chapter 9 filings. In the first nine months of this year,
there were nine Chapter 9s, none by a
city or town or what most people think of
when they hear the word “municipality.’’
They included hospital, levee and sanitary
improvement districts.
In 2009, investors added almost $81.1
billion to municipal bond funds, according
to Lipper US Fund Flows. In 2010, they
added $5 billion. In 2011, as investors
panicked after the Meredith Whitney call,
they withdrew $14.4 billion. In 2012, they
added $46 billion.
Yield indexes shot higher. The oldest gauge of municipal yields, the Bond
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Bloomberg Brief | Muni Meltdown 28
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Buyer’s 20-Bond General Obligation
Index, rose from 3.82 percent on Oct. 14,
2010 to 5.41 percent on Jan. 20, 2011. The
index fell throughout 2011 and 2012, rose
in 2013, fell in 2014, and is now in the 3s.
States and municipalities reduced
spending, raised taxes and fees, balanced
their budgets and fired employees. States
had 5.2 million employees on Jan. 31,
2009, which they cut to just over 5 million
by the end of July 2013. Local governments had 14.6 million employees in October of 2008; they fired almost 600,000
by March of 2013. Both have resumed
hiring, albeit slowly.
States and municipalities slowed their
borrowing in the bond market. In 2010,
they sold almost $408 billion in long-term,
fixed-rate municipal bonds. This declined
to $258 billion in 2011, rose to $352 billion
in 2012, dropped to $298.7 billion in 2013,
and currently stands at about $220 billion.
If I can generalize: If a Municipal Market
Meltdown did not and has not occurred,
what did happen?
States and municipalities, with a few
exceptions, muddled along. Federal assistance in varying degrees and interest-rates
held near zero by the Fed eased the way.
Beware Inexpert Testimony
What can we learn from the hysteria?
Are there any lessons that investors can
learn from the panic of 2010?
First: Remember my friend Paul Isaac’s
dictum: The municipal market is particular and specific to a remarkable degree.
Hysteria proponents either ignored, or
(my bet) didn’t know about the incredible variety of securities and credits sold
generically as “municipal bonds.’’ They
generalized.
Second: Beware inexpert testimony offered on the Internet. Not all points of view
are legitimate and credible.
Third: Politics and municipal credit
analysis make strange bedfellows. Many of
the dire predictions about the market were
politically informed, driven by an almost
visceral hatred of municipal labor unions.
Consider, for a recent example, a September editorial in the Wall Street Journal
about Sen. Chuck Schumer’s support
for munis as high quality liquid assets for
banks. Schumer urged federal regulators
to reconsider their decision to prohibit
banks from considering munis as such
assets, saying it might even slow or halt
infrastructure projects.
The Journal observed: “That ‘infrastructure’ line sounds nice, but Mr. Schumer’s
real purpose is to keep the money flowing
to his friends in local government so they
in turn can keep the money flowing to
union employees.’’ I thought: Is this really
what the Journal editorial board considers
the only pupose of municipal borrowing?
Fourth: Municipalities — that is, those
who are legally allowed to (not all states
Source: Bloomberg/Pete Marovich
Defending Munis: Sen. Chuck Schumer
allow it) — will do all they can to avoid
filing for Chapter 9, which by design is
onerous, extremely expensive and, yes,
carries a stigma. The corollary to this
observation is that when they do file, the
corporate attorneys and advisers involved
will target bondholders as easy prey. Even
the conservatives in Orange County for
a very brief period early in the county’s
bankruptcy in 1995 talked of “repudiating’’
certain bonds sold only the year before.
One of Detroit emergency financial manager Kevyn Orr’s very first gambits was to
declare that general obligation bondholders were unsecured and entitled to only
cents on the dollar.
Fifth: Twitter is a good source of breaking
news and analysis. Dismiss it at your risk.
Bloomberg Brief: Muni-Meltdown That Wasn’t
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Bloomberg Brief | Muni Meltdown 29
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Bloomberg Brief | Muni Meltdown 30
Appendix 1: Meredith Whitney Overreaches With Muni Meltdown Call
COMMENTARY BY JOE MYSAK
Dec. 22, 2010 (Bloomberg)
There will be between 50 and
100 “significant’’ municipal bond
defaults in 2011, totaling “hundreds of billions’’ of dollars.
So said banking analyst and new municipal bond expert Meredith Whitney
on the “60 Minutes’’ show on Sunday, in
perhaps the boldest, most overreaching
call of her career.
Hundreds of billions of dollars? The oneyear record, set in 2008, is $8.2 billion. You
can see how an estimate of “hundreds of
billions’’ would get people’s attention.
There are a lot of reasons to be doubtful
about the health of the municipal market
right now, as elucidated by “60 Minutes’’
correspondent Steve Kroft. Tax revenue
is down, public pension and health-care
liabilities are up, the federal government’s
bailout money to the states is running out
and the chances that those funds will be
replenished are remote.
And yet — hundreds of billions of dollars
in default? The number is in the realm of
the fabulous. If pressed, I would say that
we might see between 100 and 200 municipal defaults next year, maybe totaling
in the $5 billion or $10 billion range.
Whitney doesn’t believe the states will
default. That leaves us with local governments and authorities as the ones failing
to pay debt service on their bonds, which
makes this an even bolder call.
Most defaults in the modern era aren’t
governmental or what we might call municipal at all. The majority are corporate or
nonprofit borrowings in the guise of some
municipal conduit — nursing homes, hous-
ing developments, biofuel refineries — so
they could qualify for tax-free financing.
Whitney’s Vision
And those are the ones I think will still
comprise the majority of defaults in 2011.
This isn’t the Whitney scenario. No, she
envisions between 50 and 100 — or more
— counties, cities and towns making the
choice to renege on their bonded debt.
My question is: Why?
Why would a governmental entity go out
of its way to provoke or alienate its best
source of finance? In the old days you
might say that bondholders were a distant
class of banks and plutocrats mainly centered in the Northeast. That’s no longer
true, and hasn’t been since at least the
passage of the Tax Reform Act of 1986,
which made bonds less attractive for
banks and insurance companies, among
other things. Today, a city’s bondholders
might live in the municipality itself, and
almost certainly reside within the state.
Debt Service
Why would a governmental entity
choose to default on its bonds, especially
if they make up a relatively small proportion of its costs?
“Debt levels for U.S. local and state
governments are relatively low, with annual debt service representing a relatively
small part of budgets,’’ Fitch Ratings said
in a special report in November.
Entitled “U.S. State and Local Government Bond Credit Quality: More Sparks
Than Fire,’’ the report said, “The tax-supported debt of an average state is equal
to just 3 percent to 4 percent of personal
income, and local debt roughly 3 percent
to 5 percent of property value. Debt service is generally less than 10 percent of a
state or local government’s budget, and in
many cases much less.’’
The lead analyst on the report was
Richard Raphael, who has been covering municipal finance for 31 years. He is
not one of the analysts “who got everything wrong in the housing collapse,’’ in
the words of correspondent Kroft. In his
report, Raphael said, “debt service is a
relatively small part of most budgets, so
not paying it does not do much to solve
fiscal problems (particularly as compared
to the costs of such an action).’’
Headline Grabber
What irks me about this Whitney call is
that it generalizes about a market that
resists generalization, a market that is
particular and specific to a remarkable
degree. And it doesn’t answer the question
“Why?’’ It is instead an assertion aimed at
getting attention.
Whitney made headlines in 2007 when
she predicted Citigroup would lower its
dividend and that it was time to sell bank
stocks. She made headlines in September
when she said she produced a report on
15 states’ financial condition, and said the
federal government might be called upon
to bail them out. Whitney only let clients
see the report, so I don’t know if her conclusions are supported. She said it was
600 pages long and had taken two years
to produce.
Perhaps Whitney should stick with
bank stocks.
Debt levels for U.S. local and state governments are
“relatively
low, with annual debt service representing a
relatively small part of budgets.
”
— Richard Raphael, Analyst
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Bloomberg Brief | Muni Meltdown 31
Appendix 2: Muni Meltdown That Wasn’t Confounds Market’s Earliest Critics
Dec. 13, 2011
Before Meredith Whitney predicted that
municipal defaults in 2011 would total
“hundreds of billions of dollars’’ in a Dec.
19, 2010 broadcast of CBS Corp.’s “60
Minutes,’’ several analysts made similar
claims about the imminence of defaults
and bankruptcies at the state and local
levels. Four people who previously wrote
or spoke about the problems facing the
market in 2011 discussed their previous
statements, why the market held together
this year, and what the future holds for
state and local issuers with Municipal
Market’s Brian Chappatta.
‘California Will Default’ Christopher Whalen: My basic view
hasn’t changed, and my comment was really more of a medium-term issue. In other
words, they’re going to try to raise taxes in
California, but they’re not going to get very
far. The whole West is like this. They’re
antithetical to taxes, especially property
taxes. The whole point of the comment
was that eventually, the politicians are going to have to use the threat of default to
move the political process. And I still think
that’s the case. Illinois is arguably worse
than California now, because they haven’t
done anything.
I was pretty critical of New York last year,
but Andrew Cuomo is doing very well.
He’s well ahead of the other two states.
My sense is we still have a risk of at least
threatened political default, like we went
through with the budget last summer.
The question is: What do you do in a flat
environment in terms of employment and
the real estate market, where there’s no
automatic appreciation in the tax base?
That’s the big issue I see. If we’re going
into a period with flat or down real estate
prices, that’s not going to help anybody
maintain revenues versus rising expenses.
So there’s a squeeze here between
revenues and expenses and I don’t think
that’s going to change.
I’m not an end-of-the-world guy. What
I do think is everyone’s premise about
revenue and growth has to change, and
that’s going to ripple through politically,
especially in Illinois. I could see them
default, simply because the politics are
not aligned correctly for people to deal
with the issue.
“The biggest thing I didn’t
understand when I wrote that
paper, which I understand
now after I talked to some
people who have really been
involved in municipal government, is how hard a state will
work to avoid any default on a
GO bond.”
— Frederick Sheehan, Author
In the 80s, when we had the S&L crisis,
it took us almost 10 years — three congressional elections — to change the mix
in Congress so they would actually deal
with it. And we’re going through the same
thing now. We may have to not only have
an election next year but also an election
two years later before you get the mix in
Congress changed so they’ll actually do
this. The old guard politically, they don’t
want to deal with this.
I haven’t really changed my outlook, but
I’m not a doom-and-gloomer. I just think
politics, especially in the West, are going
Source: Bloomberg/Andrew Harrer
Andrew Cuomo
to have to get involved at some point,
because the population there is still pretty
recalcitrant, and they don’t think they
should have to pay more taxes. They’re
talking about raising expenditures for the
schools. Yet we don’t have the money. But
they don’t want to hear it.
Christopher Whalen is managing director of Institutional Risk Analytics, a Torrance,
California-based bank-rating firm. He said in
an interview with Henry Blodget on Yahoo
Finance’s Tech Ticker in November 2010 that
California will default. Blodget, who is also the
chief executive officer and editor-in-chief of
Business Insider, later posted on the site the
headline:“CALIFORNIA WILL DEFAULT ON
ITS DEBT, Says Chris Whalen.’’
‘Let States Go Bankrupt’
David Skeel: Politically, things have
changed since I wrote that piece in terms
of the likelihood of it going anywhere in
Congress. The political enthusiasm for
the state bankruptcy idea has temporarily
dimmed. The problems haven’t gone away.
I still think bankruptcy would significantly
improve our ability to deal with a crisis. If
the Eurozone crisis were to deteriorate
further and have ripple effects here, things
could quickly get worse than they are.
It has always been quite possible that
nobody would get to the edge of default.
One of the arguments against bankruptcy
for states is the downturn is largely cyclical and they’ll almost certainly be able
to muddle through. I think that may be
right, but it doesn’t seem to be a basis for
saying we don’t need to do anything else.
It’s like saying there’s no need to have a
fire department because we haven’t had a
fire. So the arguments for a state bankruptcy framework remain compelling.
One of the criticisms of bankruptcy as
a solution is it doesn’t solve the political
problems. The reason states get into so
much trouble is usually because there’s
some breakdown in the political process.
Bankruptcy is not a silver-bullet solution
to that. If you’ve got political problems,
they’re probably not going to disappear,
but bankruptcy does point in the right
direction.
Another criticism of bankruptcy is if you
continued on next page...
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Bloomberg Brief | Muni Meltdown 32
continued from previous page...
put a bankruptcy framework in place,
states would find it really hard to buy, and
it would just cripple them in terms of borrowing. If you look at countries that have
defaulted, they’re regularly able to go
back to the market within a year or two.
It’s not like they’re shut out forever. In the
short-run, they often pay more for credit,
but sometimes it’s not that much more.
What we’re seeing now is that the
higher levels of government are suffering so they’re cutting off funding to lower
levels of government. States are being
hit because the federal government is in
worse shape, and localities are being hit
because states are in worse shape. It’s
quite possible that these trends are going to increasingly come to the surface,
and we may end up with a very serious
debate about whether bankruptcy is
something we should be doing. My guess
is it probably doesn’t happen before next
November. It’s a political hot potato, so I
doubt anybody is going to be pushing it
during the election season. But I could
easily see it coming quickly thereafter.
The disclosure issues with municipal
debt, state debt and pension obligations, that’s the sort of thing that could
get bipartisan political support. That’s
what I would expect to see in the coming
months: measures short of state bankruptcy getting serious attention, and then
if things get radically worse, we might
have that bankruptcy debate again.
We’re seeing significant bankruptcies
in the municipal context. It’s possible
Harrisburg will end up back in bankruptcy next year. Jefferson County is in
bankruptcy now. So the old argument
that significant municipalities don’t file for
bankruptcy isn’t true anymore. If significant municipalities are finding themselves in bankruptcy, it’s certainly not out
of the question it would be an issue for
the states.
David Skeel is a professor of corporate law
at the University of Pennsylvania Law School.
He wrote an article for The Weekly Standard
in November 2010 titled “Give States a Way
to Go Bankrupt,’’ in which he said bankruptcy
would be the best option to avoid a “massive
federal bailout.’’
The Next Bubble
Richard Bookstaber: I can’t speak with
the press because of my government
positions. Also, I have not kept abreast of
the muni market.
Richard Bookstaber is a senior policy adviser
at the Securities and Exchange Commission. On
April 4, 2010, he wrote on his blog, rick.bookstaber.com, an entry titled “The Municipal Market,’’ in
which he said the municipal market was the next
source of crisis. He cited a variety of criteria, and
said ``once a few municipalities default, there is a
risk of a widespread cascade.’’
‘Dark Vision’
Frederick Sheehan: In that paper, if I
had predicted any timing, I would have
been wrong. I expected many more
defaults than there have been by now.
What I think at this point is that there are
some real problems that are going to
lead to a lot more defaults. Incomes are
falling in the country, so taxes are going
to continue to fall in municipalities. Even
through there’s talk about reducing costs
and cutting back, they’re continually short
of where they’re going to need to be with
reduced revenues.
I think there will be a lot of trouble, and a
lot of defaults. I think it will be, in the end,
at least a couple hundred billion dollars in
general obligation bonds. It depends on the
project, but they are generally more risky.
Defaults will come within two or three
years, because the trend I mentioned is
going to keep working against municipalities and states. Incomes are not going
to improve. House prices are not going
to rise. Pension contributions will go up.
Weariness will set in, where they are
doing what they think they need to do in
order to reduce costs, but they have to run
harder just to stay in place.
The biggest thing I didn’t understand
when I wrote that paper, which I understand now after I talked to some people
who have really been involved in municipal
government, is how hard a state will work
to avoid any default on a GO bond. If you
just look at the numbers, you would expect
the state is really up against it and doesn’t
have long to go. But after talking to some
people, it’s clear that is the last thing that
a state wants. To not be able to borrow —
they will do anything to avoid that.
Municipal bonds are not well understood, and I have found that out since I
wrote that paper. The people who own
municipal bonds, and even the people
who sell them often don’t understand what
they’re really buying. They can’t really
approach what they own or what they’re
selling other than as an aggregate class
of municipal bonds. They are not large,
aggregate classes. They are individual
bonds and that’s not well understood.
There is generally a presumption, even
if it’s not stated, even if it’s just out of a
tacit understanding, that if things get really
bad, the federal government will be able
to come to the states’ aid. But there is the
possibility that the federal government will
not be able to come to their aid, probably
a good chance, especially if it is in the billions of dollars. States and municipalities
could be surprised by that.
Federal money has helped prevent
default. They haven’t reached that critical
point where they couldn’t bridge the gap
by issuing more bonds. Being able to do
that has given them some time. Also, over
the past couple of years, it has become
much better understood that municipalities
are having difficulties and are addressing
them. Whether they will have addressed
those problems enough, when the additional costs of the reduced revenues start
to hit, I don’t know. It has given them a
chance to look at the situation and make
some changes that have allowed them to
continue paying the bonds.
Frederick Sheehan is the author of “Panderer to Power: The Untold Story of How Alan
Greenspan Enriched Wall Street and Left a
Legacy of Recession.’’ He wrote a piece for
Weeden & Co. called ``Dark Vision: The Coming
Collapse Of The Municipal Bond Market’’ in
September 2009. In it, he said: ``The municipal
market will probably repeat the pattern of the
sub-prime collapse. Although it is plain to see,
the usual experts do not notice.’’
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Bloomberg Brief | Muni Meltdown 33
Appendix 3: Meredith Whitney Says ‘I’m Right’ With Number Barrage: Books
REVIEW BY JOE MYSAK
June 3, 2013 (Bloomberg)
We’re all moving to North Dakota.
Or South Dakota. Or somewhere out
there in the middle of the country.
This is the thesis of Meredith Whitney’s
“Fate of the States: The New Geography
of American Prosperity.’’ The country’s
“central corridor,’’ largely untouched by
the housing bust, is going to drive the
economy for decades to come.
The “smart money,’’ she writes, “is flocking to states with lower tax burdens and
less strained budgets.’’
Fleeing the coasts is not a new idea.
I trace its modern incarnation to Rich
Karlgaard’s 2004 “Life 2.0,’’ in which the
Forbes publisher asserted that people
were leaving the crowded, overpriced
coastal states to seek “larger lives in
smaller places.’’
Now Whitney, with a barrage of numbers,
percentages, gross generalization, bald
assertion and outright error, joins the ranks
of the demographic determinists. Perhaps
the favorite word of these proponents of
the decline and fall of New York and California is “already.’’ Whitney doesn’t disappoint: “The United States is already in the
process of rebalancing itself demographically based upon opportunity and standard
of living.’’ This is already happening, she
writes. In other words: I’m right!
‘60 Minutes’
Not so fast. The idea, based purely on
dollars and cents, sounds reasonable. Yet
the evidence is thin. And using the last
five years as predictor of the next 30 is
questionable. There are lots of reasons
people move. Tax policy is low on the list.
And some states possess advantages
others just can’t overcome.
What Whitney, a banking analyst who in
2007 made her name with the call that Citigroup was going to suspend its dividend,
is doing here is defending her December
2010 appearance on “60 Minutes.’’
At the time, Whitney had spent two and
a half years on an otherwise unremark-
The “smart money is flocking to
states with lower tax burdens and less
strained budgets.”
— Meredith Whitney, Author
able piece of research, a punctuation
mark to the hysteria about public finances
common during the latter stages of the
financial crisis.
To correspondent Steve Kroft, Whitney
predicted that the unhysterical experts
were wrong, and that the municipal market
would see “50 to 100’’ significant defaults.
‘Hundreds of Billions’
Nobody had a problem with that figure.
The average since 1980, according to
Distressed Debt Securities Newsletter
data, is 111 defaults per year totaling an
average of $3 billion.
Asked to put a dollar amount to the prediction, Whitney blurted out, “hundreds of
billions’’ of dollars. Instead of challenging
this absurd figure, Kroft just gave one of
his crinkly-eyed, sorrowful shakes of the
head, pitying all those bondholders.
Investors panicked and pulled $26 billion
out of muni mutual funds over the next
few months, according to Lipper U.S. Fund
Flows data. Whitney got a ton of attention,
and not coincidentally a book contract.
Connect the Dots
Whether we will all move to Kansas is
debatable. What isn’t are the factual errors
on display here.
Experts, Whitney writes, are “quick to
point out that states have never defaulted.’’
Who are these experts? The ones I know
acknowledge that Arkansas was the last
state to default, in 1933.
Cities “just assumed that their states
would be there to bail them out.’’ On the
contrary, most local officials know that recourse to the states is limited and punitive.
“Jefferson County’s finances were sunk
by a water-and-sewer project that, thanks
to graft and engineering blunders, never
actually got built despite the county’s borrowing and spending billions.’’ Never got
built? That isn’t true.
Orange County, California, bondholders
“would not have been repaid had it not been
for a bailout by the state of California.’’
Bailout? State lawmakers allowed the
county to divert tax revenue from certain
county agencies to back a bond issue
used to repay obligations. No one considered this a bailout.
In the introduction to “Fate of the States,’’
Whitney writes, “My brain instinctively
works to connect the dots in life, turning
mosaics of information into narrative tales
of how things came to be and what I think
will happen as a result.’’
That way madness lies. There are
89,004 local governmental entities in the
U.S. Take four or five or a dozen headlines
and “connect the dots,’’ and you no doubt
have a trend, maybe even a book. What
you don’t have is an accurate picture of
municipal finance.
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