Michael Lewis and Meredith Whitney in muniland | FT Alphaville

Michael Lewis and Meredith Whitney in muniland

Following his not-so Grand Tour of Europe, the esteemed vagabond financial scribe Michael Lewis has returned home to report on California for Vanity Fair:

In our opinion, it’s not as perceptive as his articles on Greece or Ireland but it’s still worth an Instapaper click.

For municipal bond market watchers the passage on Meredith Whitney may be of particular interest. Lewis is a fan of Whitney — she features prominently in the first chapter of the Big Short — and he’s keen to defend her against critics who apparently didn’t get what she was trying to say about state and local budgets.

“You could see 50 to a hundred sizable defaults, [maybe] more,” she said. A minute later Kroft [60 Minutes anchor] returned to her to ask when people should start worrying about a crisis in local finances. “It’ll be something to worry about within the next 12 months,” she said.

But that’s not at all what she had said: her words were being misrepresented so that her message might be more easily attacked. “She was referring to the complacency of the ratings agencies and investment advisers who say there is nothing to worry about,” said a person at 60 Minutes who reviewed the transcripts of the interview for me, to make sure I had heard what I thought I had heard. “She says there is something to worry about, and it will be apparent to everyone in the next 12 months.”

Hmmm. Yes, but according to 60 minutes’ own report on the segment, she also said:

“There’s not a doubt in my mind that you will see a spate of municipal bond defaults,” Whitney predicted.

Asked how many is a “spate,” Whitney said, “You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars’ worth of defaults.”

Whitney’s prediction for the municipal market has been getting a bit of replay on Thursday, for it was about a year ago that she first warned of impending doom in local government finances.

It’s tempting to dismiss her warnings since after a panicked few months municipal bond spreads began to narrow in the late spring and state revenues picked up again. And she has hardlly helped herself by flaky definitions of what she meant by “defaults”.

But we think Lewis has a point when he says what Whitney was trying to say could have been of great importance:

The country, she thought, might organize itself increasingly into zones of financial security and zones of financial crisis. And the more clearly people understood which zones were which, the more friction there would be between the two. (“Indiana is going to be like, ‘N.F.W. I’m bailing out New Jersey.’ ”) As more and more people grasped which places had serious financial problems and which did not, the problems would only increase. “Those who have money and can move do so,” Whitney wrote in her report to her Wall Street clients, “those without money and who cannot move do not, and ultimately rely more on state and local assistance. It becomes effectively a ‘tragedy of the commons.’ ”

Now that’s an interesting thesis, albeit one that is hardly a new story for anyone with a sense of US history. The problem wasn’t, though, what Whitney said, or what she tried to say, but the fact that she offered next to no public defence for her argument. Here’s Lewis again:

That was the amazing thing: she had offered nothing to back up her statement. She’d written a massive, detailed report on state and local finances, but no one except a handful of her clients had any idea what was in it. “If I was a real nasty hedge-fund guy,” one hedge-fund manager put it to me, “I’d sit back and say, ‘This is a herd of cattle that can be stampeded.’ ”

That’s precisely what some did, of course.

And therein lies the rub.

It’s positively swell for a smart outside voice to enter the stuffy echo chamber of the municipal market. The market that underpins pensions and life savings, and funds America’s school districts, housing projects, hospitals and roads should be better understood and scrutinised. It’s a farce, for instance, that we don’t even know how big it is — and could be $775bn out.

But when analysts use their celebrity rather than evidence to make their points, especially about an illiquid market that is underpinned by retail investors, it behooves them to back up what they’re saying. This doesn’t have to mean releasing proprietary research to the uneducated hoards, but an executive summary or two wouldn’t hurt. Because if that happened we could call out guff like this:

The point of Meredith Whitney’s investigation, in her mind, was not to predict defaults in the municipal-bond market. It was to compare the states with one another so that they might be ranked. She wanted to get a sense of who in America was likely to play the role of the Greeks, and who the Germans. Of who was strong, and who weak. In the process she had, in effect, unearthed America’s scariest financial places.

On face value this comparison is mostly silly for the reasons we outlined here. US states have many problems and California in particular suffers from a bonkers political system. That doesn’t make it Greece. Nor does it make Indiana Germany.

But perhaps there’s some real insight here that we don’t know about. Because regardless of whether she was the first person to say so or not, real insight is what Whitney brought to banks before the financial crisis, and there’s no reason why she can’t do the same in a new field. Let’s hope so; otherwise it’s just all noise.

Related links:
California or Bust — Vanity Fair
Meredith Whitney and the muni fifth dimension – FT Alphaville
Meredith Whitney’s anniversary – Muniland