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Meredith Whitney's Muni Prediction Draws Scrutiny

If one stock-picker emerged intact from the wreckage of the financial crisis, it was Meredith Whitney.

Meredith Whitney on Closing Bell
CNBC
Meredith Whitney on Closing Bell

With a prescient warning about bank stocks in 2007 — as well as a gift for the perfect sound bite — she became a media darling, celebrated in a Fortune cover article and in frequent television appearances as a market seer.

Until now, that is. These days, Ms.Whitney, 41, finds herself pilloried in the news media and by colleagues for predicting a calamity in municipal bonds.

Critics say the call is overstated, but it has alarmed investors in that usually sleepy market.

Ms.Whitney is also drawing scrutiny from Washington, where a Congressional panel will meet on Wednesday to examine the turmoil in the muni bond market, including whether Ms.Whitney’s call has fed the volatility and allowed some investors to profit unfairly.

Citing scheduling conflicts, Ms.Whitney has declined an invitation to appear before the panel of the House Oversight and Government Reform.

But the subcommittee’s chairman, Representative Patrick T.McHenry, Republican of North Carolina, said that would not dissuade him from investigating her record.

“This isn’t a gotcha thing, but she’s going to be part of the hearing, whether or not she participates,” he said. “If she doesn’t want to come forward in a venue like this, that makes a statement.”

Ms.Whitney has not been shy about making statements in the past, whether it was delivering bold predictions about unemployment or dressing up as Paris Hilton for her firm’s Halloween party.

But her scathing report on deteriorating state finances in September, followed by an appearance on “60 Minutes” in December, has been catnip to her critics.

“There’s not a doubt in my mind that you will see a spate of municipal bond defaults,” she said in the “60 Minutes” interview. “You could see 50 sizable defaults, 50 to 100 sizable defaults, more. This will amount to hundreds of billions of dollars worth of defaults.”

Normally, Wall Street analysts are loath to criticize one another, at least on the record.

But since then, even fellow analysts are calling her out for stepping beyond what she knows, bank stocks, into less familiar territory.

Others, especially municipal bond market players, have gone on the warpath.

“I’ve seen a copy of the report, and frankly, I’ve seen better papers from graduate students in finance,” said Richard P.Larkin, director of credit analysis at Herbert J.Sims & Company, a municipal bond broker and underwriter. “It’s ludicrous, reckless and irresponsible, and it’s being done without any regard for the consequences.”

Investors were pulling money out of municipal bond funds even before Ms.Whitney’s appearance on Dec.19, but in the weeks since, the pace of withdrawals has accelerated, with more than $14 billion coming out between Dec.22 and Feb.2.

Ms.Whitney declined to comment for this article.

But a number of academics and others who have studied pension, health care and other obligations of states and municipalities say bigger problems loom than just short-term budget deficits that stem from the recession.

They see structural problems that may require decisive, painful action in the most indebted places.

But it is Ms.Whitney’s contention that hundreds of billions of dollars’ worth of defaults could come to pass that has aroused a firestorm.

“Meredith’s analysis highlighted problems in the muni market that have been known for years,” said Josh Rosner, a structured finance analyst at Graham Fisher & Company.

Still, she has gone too far in his view.

“She drove a rush to the exits,” he said, “which wasn’t about the fundamentals, but about a momentum trade.”

To be sure, few market oracles have been able to repeat the brilliance of their first call.

A timely warning shortly before the crash of 1987 made Elaine Garzarelli into a guru, but her star faded after she left her Wall Street perch and started her own firm in 1995.

The technology bull Henry Blodget became famous when the tech bubble inflated and infamous after it burst.

Indeed, some fund managers say Ms.Whitney’s recent stock picks have not been money-makers.

“She missed the huge recovery in financial stocks after correctly calling the downturn,” said Michael Scanlon, senior investment analyst at John Hancock Asset Management. “The history of Wall Street is littered with people who got one big call right.”

Ms.Whitney’s latest call has left observers like him puzzled: “She has no experience in the municipal bond market, so she’s got an uphill battle to establish credibility with the experts.” Plenty of critics howled when she warned of the coming flood in 2007 and told clients to stay away from stocks like Citigroup.

This time, people are listening again, but the critics are also going further, questioning her timing — and motivation.

That is because even as she roils the muni bond market, Ms.Whitney is trying to expand her firm, the Meredith Whitney Advisory Group, and get into the business of rating municipal debt.

“I think it was self-interest to go on prime time to pump up her future business,” said Matthew McCall, president of the Penn Financial Group, an investment advisory firm that holds muni bonds. “We know municipalities are in trouble. To say they will go belly up is uncalled for. She did this purely to market her firm.”

Ms.Whitney has refused to release her September report or provide it to Congressional staff.

Copies have leaked out, however, and as Bloomberg News and Charles Gasparino of Fox Business Network have pointed out, the tone of the report is much more measured than Ms.Whitney herself was in the “60 Minutes” appearance.

Not that Ms.Whitney was shy about drawing comparisons between financial problems in the states and the financial collapse that made her famous.

“We believe the financial challenges facing states could be the next systemic risk within the U.S. financial markets,” she wrote in the report, a copy of which was provided to The New York Times.

Ms.Whitney also draws comparisons between the risk-taking on Wall Street and the budget practices at many state governments.

In fact, there are important differences between the problems facing states and municipal governments, bad as they may be, and those the banks encountered during the financial crisis.

For starters, states have the power to raise taxes — something private companies with a shortfall cannot do, Mr.Rosner of Graham Fisher said.

They can also try to force concessions from their workers in terms of reduced pay and benefits, in some cases.

Even if municipal issuers run into distress, a financial control board can shield bondholders from a default, as happened recently in Nassau County.

These boards usually create a so-called intercept, or a structure that can grab new tax dollars as they come in, before they can go into the locality’s general fund.

The money goes into a special fund to pay the bondholders their interest and principal, a system that prevents elected officials from spending it on other things.

In cases where financial control boards cannot prevent a default, the bondholders may not notice because the bonds are insured.

When Vallejo, Calif., went into Chapter 9 bankruptcy a few years ago, for instance, the bondholders continued to be paid, at least at first, by an insurance company.

Ms.Whitney’s defenders say she is doing what she has always done — provoking investors into asking uncomfortable questions.

“Like you or hate you, if you force investors to think, then you’ve done your job as an analyst,” said Richard X.Bove, a banking analyst at Rochdale Securities. “She’s separated herself from the pack and made herself distinctive and unique.”