Yes, the States Will Need a Bailout, but Muni Bondholders Should Be Fine

Last Updated Sep 30, 2010 4:09 PM EDT

Star banking analyst Meredith Whitney says the federal government will come under pressure to bail out states in the next year. True enough, but a catastrophe for municipal bondholders still looks pretty unlikely.

Whitney's 600-page report (not public) is bound to get all sorts of attention thanks to her history as a savant in the banking crisis. (As did Warren Buffet's warning about the states and cities a while back.) Indeed, she's not shy about invoking the recent past when discoursing on the states. "I see a lack of transparency and an abundance of complacency on the part of investors and politicians, just as we saw before the banks imploded," Whitney told Fortune.

However, the notion that investors are somehow blind to the fiscal distress among states and municipalities is just plain wrong. Take a look at how the announcement that Harrisburg, Pennsylvania would default (it got aid from the state a few days later) got attention in the markets. Ditto the case of Vallejo, California, which declared bankruptcy. Investors are ignorant? Hardly.

Municipal Market Advisors, no slouch in this department, commented that the Whitney report:

appears to succumb to what has been a common problem of nonmunicipal observers of our market: the conflation of various state stakeholder exposures. Because, while states' financial conditions are undeniably stressed now and will reasonably remain stressed for the next decade or more, [general obligation] bondholders are generally well cushioned versus other interested parties-taxpayers, service recipients, employees, vendors-who will feel pain more directly. In part, this point respects the strong structural protections of bondholders- how exactly they fit, by constitution or statue, within the cash flow of state tax receipts-and the strong culture of willingness to pay-in particular at the state level-that has developed over the last several decades and, from our observation, shows no sign of wavering.
Less verbosely: everyone but investors will suffer, precisely because there are so many built-in protections against state (and even municipal) defaults. So it's not entirely clear to me who, on Wall Street that is, Whitney thinks is misconstruing the situation.

Markets are good at assimilating information. In fact, they seem to have done so -- even before Meredith Whitney landed her 600-page report on investors' desks.


  • Carter Dougherty

    Carter Dougherty, a former economic correspondent for the International Herald Tribune and The New York Times, is fascinated by the intersection between policy and business, in the United States and abroad. He shared in a Loeb Award, business journalism's most prestigious, while at the NYT. But he still looks back fondly on his days trudging through central Africa, reporting on Congo, Darfur and other rough spots.