Just about a year ago today, rumors started to circulate in the sometimes sleepy and boring world of municipal finance.
Jin Lee | Bloomberg | Getty Images
Meredith Whitney
The gist of the story was that a highly influential analyst was about to release a bombshell negative report. For portfolio managers running non-taxable bond funds, this was exciting.
Within asset management firms, these guys are way down in the social hierarchy; they normally sit in non-descript offices next to money market portfolio managers, chatting about things like duration, credit quality, and interest rate forecasts.
The actual release date of the "Tragedy of Commons" report still isn’t exactly clear, but Meredith Whitney was definitely deep into her non-deal road show by Nov. 11, when she appeared on CNBC.
Thus began a significant decline in municipal bond prices.
The crisis talk went into overdrive, of course, when Ms. Whitney appeared on 60 Minutes and warned that the $3 trillion municipal bond market faced the immediate threat of hundreds of billions of dollars in defaults.
To me, Ms. Whitney’s numbers didn’t add up. There was never a question, even in the bullish muni camps, that states had to get their budgets in-line.
State spending, just like federal spending, had gotten completely out of whack with revenue collection over the last decade.
Many people felt that Whitney was just was making a macro call. That all changed when she said on 60 Minutes, "there is not a doubt in my mind you will see a spate of municipal bond defaults ... you could see 50 to 100 sizable defaults, more. This will amount to hundreds of billions of dollars worth of defaults."
GAME CHANGER. That's when panic set in because this prediction became specific and micro on the expected amount of losses. The huge numbers seemed exaggerated and headline seeking, given the historical default rates through many other recessions and periods of negative economic growth.
Additionally, most states were reporting better tax revenues and more promising outlooks for their financial conditions.
Nevertheless the muni market began to react violently.
While managing money over a twenty-plus year period I focused on fundamentals of companies but made ultimate investment decisions incorporating respect for technical indicators as well. In the same way, listening to macro calls should not be ignored or discounted.
However, the lesson here for investors is simply to not allow dramatic headlines to alter a well thought out long-term investment plan. Many retired individuals who had allocated money to municipal bonds did just that.
It also dawned on me that when you question celebrity analyst work, you enter the “groupie” zone. That had been the case during the tech bubble of 1998-2000. Critics of Mary Meeker, Henry Blodget, or Jack Grubman (just to name a few) were told that they were idiots and just didn’t understand the new normal. (“Gary, are you stupid?” they’d say. “Internet traffic will double every month from now till eternity.” And so on.)
After the 60 Minutes broadcast, I spoke with loads of brokers, wealth advisors, and fixed income portfolio managers, who talked my ear off about the tremendous time they now had to spend “hand-holding” clients and defending the entire muni asset class.
In fact, compliance, marketing, and legal professionals, who had probably never even visited the floors where muni portfolio manger's sat, were now spending hours drafting research pieces and client “talking points.” The level of frustration was incredible. Why were there no regulatory bodies policing claims like the one Ms. Whitney had made? I was asked. (My response: “When an analyst sticks a $200 price target on an $80 stock you are long, do you ask the same?” Of course not. Case closed.)
Now one year later, I recently asked three top bond fund managers about their experiences. Needless to say, there weren’t many fond memories.
“It definitely increased the amount of communication we had with our client base,” said Ben Thompson, who manages $7 billion in tax-exempt bonds for Samson Capital. [Gary Kaminsky is a client of Samson Capital.]
Others spoke more bluntly about the fear Ms. Whitney’s words inspired. “It was a huge problem and for retail clients, significantly so,” said Alexandra Lebenthal of Alexandra & James.
Falling muni prices reinforced her clients’ fears, Ms. Lebenthal recalled, making it “increasingly more time-consuming and difficult” to reassure them.
BlackRock Municipal Bonds Group head Peter Hayes also had his hands full in the days. “What changed was the level of detail included in our portfolio scrubs,” he said. “The hand-holding … translated into much longer hours and longer days.”
Numerous Clients Scared Out Of Munis
Numerous clients were scared out of munis, after all, and annoyance is still running high. Even today, many brokers tell me that trying to convince a client to buy a high credit-quality triple-A muni in a balanced equity/bond account feels like selling Greek 10-year paper, or worse.
This despite the fact that the ML Muni Master Index is up 9.5 percent this year, besting stocks, corporate bonds, high-yield bonds, and essentially in line with Treasury performance. (The gains are a result of the sell-off in late 2010, decreased new issue supply, and lower interest rates.)
And not only are default levels nowhere near Ms. Whitney’s forecasts; they actually stand year-to-date at just 0.03 percent of total muni debt outstanding.
The last time I saw Ms. Whitney speak publicly, she spent no time at all discussing the Armageddon she had predicted. Unfortunately (or fortunately, depending on where you come down on this debate), that’s they way the game is played.
As for me, I did just what I suggested and took the opportunity to add to my non-taxable bond holdings; I’ve profited handsomely as a result. And should Ms. Whitney give a repeat performance, I will be ready to add more.
As I said last December: “Word to the wise: when listening to the prognostications of the gloom and doom crowd, it's always important to remember the intended audience. Often times, its hard to hear the logic amid noises.”
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Gary Kaminsky does not hold any equity positions.
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