Meredith Whitney: Could She Have Been More Wrong?

Last Updated Jul 15, 2011 11:51 AM EDT

Late last year, Meredith Whitney shook up the bond world with her daring forecast that there would be hundreds of billions of dollars in municipal bond defaults. Her dire forecast, along with support from Nouriel Roubini, likely was behind the huge amount of redemptions from municipal bond funds by individual investors.

We are now a bit more than halfway through the year, so I thought it appropriate to see how Whitney's forecast has turned out, at least so far. For the first 24 weeks of this year, roughly $600 million of municipal bonds have defaulted. To reach Whitney's forecast, we would need to see about $7 billion a week in defaults for the rest of year. Given the current pace of a bit more than $1 billion for 2011, and the fact that the previous annual high was about $12 billion, the most likely outcome is that her forecast will go down as one of the most infamous.

Making matters even worse for investors who sold municipal bonds is that municipal bond prices have increased since her forecast. For example, through July 11, the Vanguard Intermediate Tax-Exempt Bond Fund (VWITX) and the Vanguard Long-Term Tax-Exempt Bond Fund (VWLTX) had returned 4.38 percent and 4.75 percent, respectively.

Having said that, the recession has indeed increased the risks of owning municipal bonds, which has led to one minor change in recommending municipal bonds: The increased risk increases the need for diversification. That means if you own individual bonds, you should consider decreasing the maximum exposure you have to any one issuer. My firm's credit standards remain the same:

  • General obligation or essential service bonds only
  • AAA/AA or A if maturity is less than three years
This stems from our belief that the main role of fixed income is to dampen overall portfolio risk to an acceptable level. These criteria have served us well as to date no client has ever suffered a single loss from defaults on bonds we've purchased.

Given the track record of stock and bond market forecasters, one can only wonder why anyone pays attention to them. Certainly the market ignores them. And the best advice I can give (besides adopting the risk parameters mentioned above) is for you to ignore them as well.

Photo courtesy of EnergeticNYC on Flickr.
More on MoneyWatch:
Municipal Bonds: Was Meredith Whitney Right? Nouriel Roubini Misses Another Prediction Municipal Bonds: Why We Likely Won't See Armageddon If Muni Bond Defaults Spike, It Won't Be for Lack of Trying to Fix Problems How Are 2011's Sure Things Faring at Mid-Year?
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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.