The Muni War of Words Continues

May 19, 2011

David Kotok

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The Muni war of words continues. Meredith Whitney dug in her heels in a Bloomberg interview with Tom Keene and Ken Prewitt. Ms. Whitney has forecast $100 billion of defaults in Muniland for 2011. We have argued the other side and written on this subject many times.

The data flow seems to suggest that Whitney’s forecast will fall far short of her estimate. To date the 2011 defaults in Muniland are measured in the millions, not billions. Most of the bonds that have defaulted are project-oriented and fall in the junk credit category.

In addition, more and more state and local government budgets are improving from a combination of spending cuts and revenue increases. Q1 state tax revenues rose 9.1%, year-over-year according to the Rockefeller Institute for Government. This the fifth consecutive quarter of improvement. (Source: Bloomberg) In a coincidence of timing the Whitney interview and the Rockefeller Institute press release came on the same day.

We believe that the impact of budget restraint originating from the political pressure on state and local officials is intense. The US economic recovery is tepid. However, it is a recovery and not a recession. In addition, there is no letup in sight regarding pressure to cut spending. This combination portends better economic outlooks for various state and local government units. We hold to our forecast that defaults in 2011 will be much, much lower than the Whitney $100 billion estimate.

Furthermore, muni buyers who do their research and select specific bonds after careful scrutiny are able to find some terrific values. The key there is to do the homework.

Even the worst culprits in Muniland are curing their deficiencies and trying to avoid the dumbness of municipal bankruptcy or default. The Vallejo CA bankruptcy is an example of dumbness. So far, it has wasted $10 million and has nothing to show for it.

On the other side consider Harrisburg PA. It made national news with the mess arising out of its incinerator finance. Now it is actively pursuing a plan to alter the incinerator ownership and the waste flow. At the same time, Harrisburg is engaged in financial restructuring of its parking garages. The combination of the two transactions may alleviate the pressure of the original incinerator financial structure and put Harrisburg on a track to balance its debt-service pressures and its budgets. There is still much work ahead for Harrisburg to complete these transactions. The key thing to take away is that there are very substantial assets in the state and local government space and they are not being considered when these dire forecasts of massive defaults are made.

Markets are realizing that the panic selling of Munis was a mistake. The most recent week was the first time in 6 months where the flows into tax-free mutual funds were actually positive. That’s right: investors stopped being net sellers of Muni funds and became net buyers. The rally in Muni prices shows this flow reversal. Those who sold in panic when Ms. Whitney made her infamous pronouncement in December have experienced losses or opportunity costs. Those who were buyers during the falling market have done well.

We are still on the long side of Munis and see many opportunities. Again, the key is to do the homework. The cheapest area is in the longest duration where one can find very good grade tax-free Munis at yields above the nominal taxable treasury yield. Cumberland continues to be a buyer after the individual selection of each bond is completed.

Let’s segue to another type of bargain. Readers have a chance to participate in a conference call on the importance of growth as a way to repair sovereign debt financial imbalances. The notice is below. Steve Sexauer is a GIC colleague. He and Bart van Ark are both involved in organizations of which we are members. This series is free. The notice of the conference call follows.

Please join The Conference Board’s Senior Vice President and Chief Economist, Bart van Ark, as he engages a distinguished group of guests in a serious, in-depth discussion of how countries can align their policies with growth principles that will allow them to escape the seemingly insurmountable debt they have accumulated.

Guests include Nobel Prize economist Gary S. Becker, distinguished economist and MacArthur Fellow Kevin M. Murphy, and Jean Pisani-Ferry, Director of BRUEGEL (Brussels European and Global Economic Laboratory). The three-part series will be co-hosted by Stephen Sexauer, Chief Investment Officer of Allianz Global Investors Solutions, who, with Bart van Ark, has developed a productivity and spending framework that offers the promise of returning debt-to-GDP levels to a sustainable point over time.

The first webcast, with guests Gary S. Becker and Kevin M. Murphy, will be held on Wednesday, May 25th at 11 AM EST. Please click on this link: Escaping the Sovereign-Debt Crisis: Is There a Way Out? Scroll to the bottom of the screen for the short registration form. You will receive a confirmation with the log-in instructions for the 3-part series. If you have trouble with the link, type http://conferenceboard.org/subsites/index.cfm?id=2558.