Not everyone is buying into Meredith Whitney's prediction that the municipal bond market will turn into a sequel to Apocalypse Now as 50 to 100 cities file for bankruptcy in 2011. But everyone does seem to agree that states and municipalities around the nation are confronting challenges they haven't experienced since the Great Depression.
Chris Ryon, managing director of Thornburg's municipal bond funds, recalls Whitney's appearance on 60 Minutes on December 19. "My mother-in-law was on the phone before the piece with Whitney was over," he remarks.
Between December 15 and early March, the municipal bond market entered a negative feedback loop that resulted in 8% of all the assets held in muni funds getting redeemed. "For Whitney's prediction to come true, we'd need to see $4.6 billion of municipal defaults a week," Ryon says.
That simply isn't happening, at least not yet. In 2010, there were 44 different municipal bond defaults, most of them involving non-investment-grade debt. These defaults were concentrated in so-called "dirt deals" for infrastructure like roads and sewers or nursing-home-related bonds.
Craig Alexander, chief economist at TD Bank, doesn't doubt that it's possible 100 different municipal entities could default. "But they won't be major cities," he told attendees at TD Ameritrade Institutional's annual conference in February. "The expectation of $100 billion in losses is off."
In fact, the biggest default in the last 12 months was a South Carolina toll road built on speculation that real estate surrounding the highway would enjoy a development boom that never materialized. Another near disaster in Harrisburg, Pa., was averted when the state bailed its capital city out.
Some have raised questions about Whitney's motivations. Few have read her research report since she is charging $100,000 for it. She was too busy to testify in front of Congress or provide them with a copy of it, Ryon notes.
He believes that after the sell-off in the market over the last three months, investors are getting paid to take prudent risks. This doesn't mean there won't be defaults on municipal projects in areas that witnessed big run-ups in real estate prices and subsequent busts in places like California's Inland Empire situated in Riverside, as well as parts of Florida.
Could there be a big one? Yes. Ryon says the most likely candidate could be Detroit. Others mention Stockton, Calif. The Motor City is much larger in size relative to Michigan than Harrisburg is to Pennsylvania and the state of Michigan is more financially strapped than the Quaker State, so a bailout might not be an option.
What about the longer term outlook for munis as pension costs start to explode later in this decade? Here again, Ryon is more sanguine. "In 2010, the Pew Center for the States suggested state and municipal pensions were 84% funded on average," he says. There were wide variances, of course, with New York's pension system being 107% funded and Illinois coming in at 54%. California stood at 87%.