Whitney: States, Munis Risk 'Big' Defaults When Stimulus Run

Whitney: States, Munis Risk 'Big' Defaults When Stimulus Runs Out

Wednesday, 08 Jun 2011 10:20 AM
By Forrest Jones

State and local governments are going to feel a financial squeeze and risk big defaults when the federal stimulus money that has helped them cover spending gaps runs out this month, says star Wall Street analyst Meredith Whitney.

In December, Whitney told "60 Minutes" that widespread municipal bond defaults were on the way totaling the hundreds of billions of dollars. That hasn't happened yet, but that doesn't mean that the risks threatening state and local finances have abated.

"It's going to be big," she told CNBC. "What was troublesome is people took (the call) that it would have to be this year. I never said that. But that's the size we're looking at."

"We are in our fourth consecutive year of over $100 billion in state budget gaps. This month, the federal stimulus money runs out. The federal stimulus money — over $480 billion — went to states and it has padded budget gaps by 37 percent," said Whitney, CEO of the Meredith Whitney Advisory Group in New York.

The absence of this federal support is a big deal. States rely on 30-plus percent of their revenue from federal stimulus. Municipalities rely on 40 percent of their monies from states, she said.

Problems could arise this month, when fiscal years begin to wrap up for most states and serious budget cutting must begin.

States have made spending cuts, but the flow of federal stimulus money into their coffers has made it easier for some to avoid making tougher spending cuts.

And the level of unfunded liabilities is on the rise.

"The amount of unfunded pension liabilities grew by 50 percent in one year," she said. "This means you are kicking the can down the road."

State tax dollars are as equally obligated to finance pension funds and other post-employment benefits as they are to general obligation bonds.

"You have to look at the totality; 75 percent of state debt is off balance sheet. And that's what is growing so fast."

States are regular issuers of bonds and will be more likely to keep their standing in financial markets. Municipalities issue with less regularity but they issue more.

"Thirty-five percent of municipal debt is state-issued debt, general obligation debt, and 65 percent is municipal debt, or revenue supported debt," she said,

"If you understand the flow of money, you realize there is just not enough money to go around and service all of these obligations."

Federal Reserve Chairman Ben Bernanke has said record monetary stimulus was needed to fuel economic recovery, the pace of which is still not making policy makers happy.

"The economy is still producing at levels well below its potential; consequently, accommodative monetary policies are still needed," Bernanke says, according to Bloomberg.

At the same time, the Fed "will take whatever actions are necessary to keep inflation well controlled," he said.

"Overall, the economic recovery appears to be continuing at a moderate pace, albeit at a rate that is both uneven across sectors and frustratingly slow from the perspective of millions of unemployed and underemployed workers."

Meanwhile, some say Whitney has overreacted.

In May, John Bogle, founder of mutual fund giant Vanguard said getting out of municipal debt would be a mistake.

"I think Meredith Whitney paints with too broad a brush and I think painting with that broad brush has tarnished that industry. And I think if you get out of munis it’s at your peril because states and cities are taking measures not to default and these bonds offer great tax advantages (munis are free of state, local and federal taxes)," Bogle says, according to FOXBusiness.com.

"At Vanguard, we diversify to soften the impact of a possible default. Each of our portfolios owns 1,000 municipalities. No more than 1 percent investment in any single bond."

http://www.moneynews.com/StreetTalk/mer ... /id/399256