Meredith Whitney Is Right About Munis


Imagine for a second that you are a financial analyst, financial advisor, institutional investor, or trader who specializes in municipal bonds. Your goal, presumably, is to determine which municipalities in the United States are creditworthy enough to justify lending money to them.

Ideally, you hope to be able to pick up bonds that are dirt cheap, have a high rate of return, and that have very low chance of defaulting. This goal is usually difficult to achieve, because bonds with the lowest risk of default usually have the lowest rate of return, and vice versa for those with the highest rate of default.

Under certain circumstances, however, it is sometimes possible to pick up low-risk bonds at bargain-basement prices. If, for example, thousands of banks are forced to sell off their bond portfolios to cover losses they are suffering on other toxic assets on their balance sheets (mortgage backed securities, for instance), bond traders like yourself can take good bonds off their hands for a pittance.

As another example, if people become unreasonably bearish about the creditworthiness of municipal governments and start liquidating their bond portfolios, (because, say, a financial analyst that people trust makes a completely idiotic call), you can pick up the bonds they are stupidly selling at ridiculously low prices.

As a professional investor, you love it when these rare events present themselves. Since you know the market, and you have an insider's view into the creditworthiness of municipal governments, you want nothing more than to be able to buy up good, dirt-cheap bonds and make a veritable killing off the interest. Early retirements are secured in such ways.

Given that you stand to make a fortune by buying up bonds that people stupidly sell under rare circumstances, is it conceivable that you would go on television and try to talk people out of selling their bonds cheaply to you? The answer, of course, is that you would never do such a thing as a professional investor. That would be like a homebuyer going out of his way to publicly talk sellers into charging him higher prices, or an art dealer going on television to tell his artists to charge him more. Bankruptcy and unemployment are secured in such ways.

Yet this is precisely what we are being asked to believe about bond traders, financial analysts, and other supposedly enlightened personalities in New York and Washington, who have smeared Meredith Whitney in droves in the wake of her bombshell call on the municipal bond market. Whitney is predicting "50 to 100 sizable defaults" in the municipal bond space this year alone.

The tamping down of Whitney's call has been truly remarkable, given that the majority of the people blasting Whitney stand to make an absolute fortune if she is wrong. Indeed, the only groups who do not stand to make money off of Whitney's call, if she is wrong, are the municipal governments themselves and investors who are too dumb or slow to take advantage of it.

Think about it. If Whitney is right about this call, smart investors will all get out of municipal bonds immediately, if they are not out of them already. If she is wrong, however, and people flee municipal bonds unreasonably just on the basis of her reputation (she accurately predicted the collapse of Citigroup before anyone), the smart investors will still get out of municipal bonds immediately so that they can buy back the same bonds in eight months for half the price. Either way, smart investors will get out now, and they will not try to talk other people out of selling. This is especially true if Whitney is wrong, because smart investors will want other people to sell off massively so that they can buy back the bonds as cheaply as possible.

Given this, the fact that so-called professional investors are trying to smear Whitney and stop a sell-off reeks of a con. At best, they are trying to prop up a collapsing market long enough to get themselves out. In other words, they are public liars at best. At worst, they realize that Whitney is right, are holding massive amounts of this toxic paper, and are praying to God for either a miracle or a bailout.

This is not going to turn out well for the little guys who are taken in by this con and hold onto their municipal bonds. Especially since Meredith Whitney is right.