Muni Meltdown That Wasn’t Confounds Market’s Earliest Critics

Before Meredith Whitney predicted that municipal defaults in 2011 would total “hundreds of billions of dollars” in a Dec. 19 broadcast of CBS Corp.’s “60 Minutes,” several analysts made similar claims that the market would collapse.

With less than three weeks left in 2011, their predictions haven’t materialized. Municipal defaults will total $20 billion in 2011, according to Richard Lehmann, publisher of the Distressed Debt Securities Newsletter. That would exceed the previous high of $8.62 billion in 2009, though fall short of the $100 billion forecast by Whitney.

Four people who wrote or voiced opinions about the municipal market in 2011 discussed their comments, why defaults remained limited to a few municipalities, and what the future holds for state and local issuers for today’s issue of the Bloomberg Brief: Municipal Market newsletter.

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 would default.

Q: Do you still agree with what you said last year, which was that California will default on its debt?

A: 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.

Q: What do you predict will happen in the municipal market going forward?

A: I’m not an end-of-the-world guy. What I do think is everyone’s premise about revenue and growth has to change. I could see Illinois default, simply because the politics are not aligned correctly for people to deal with the issue.

David Skeel, a professor of corporate law at the University of Pennsylvania Law School, wrote an article for The Weekly Standard in November 2010 titled “Give States a Way to Go Bankrupt.” They were left out of a Depression-era law that lets municipalities reorganize their finances under Chapter 9 of the bankruptcy code. Skeel wrote that bankruptcy would be the best option to avoid a “massive federal bailout.”

Q: Do you still agree with what you said last year, which was that states with financial strains should be able to file for bankruptcy?

A: 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.

Q: Why have no states defaulted?

A: 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 muddle through. 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.

Q: Do you expect bankruptcy as a future possibility for states?

A: 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.

Richard Bookstaber is a senior policy adviser at the Securities and Exchange Commission. On April 4, 2010, he wrote on his blog,, an entry titled “The Municipal Market,” which he called the next crisis. “Once a few municipalities default, there is a risk of a widespread cascade,” he wrote.

Bookstaber said via e-mail: “I can’t speak with the press because of my government positions. Also, I have not kept abreast of the muni market.”

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 the welling@weeden newsletter 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.”

Q: You said two years ago that the municipal market would collapse. Why haven’t there been more defaults?

A: 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.

Q: How widespread do you predict these municipal defaults will be?

A: 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.

Q: When do you expect all these defaults to happen?

A: Defaults will come within two or three years.

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