Precious Metals

Municipal Bond Default Looms in 2011

As we enter into the New Year of 2011 a recent interview on CBS 60 Minutes featured an urgent warning to all municipal bondholders and investors across America from Meredith Whitney. Who is Meredith Whitney? She is the CEO of Meredith Advisory Group in New York that focuses on macroeconomic and strategic financial research for investment firms and industry leaders. In 2006, Ms. Whitney alerted the FDIC of risks in the sub-prime real estate market. In 2007, she wrote prolifically on the internal conflicts of interest within the New York rating agencies cartel of Moody’s, S&P and Fitch. In 2008, her firm began extensive research into the bankruptcy and insolvency of state and local budgets and her findings are finally being released to the public (www.meredithwhitneyllc.com). In the following 13-minute video clip Ms. Whiney relates her difficulty in getting cooperation from state and local authorities but her research is now considered the most comprehensive overview of this looming crisis that will affect almost $3 trillion dollars in the municipal bond complex.

At this very moment, cities and states all across this country are facing their day of reckoning, with far-reaching consequences for the economy, investors and every American citizen.

This morning, I will show why this day is so urgent, how to protect yourself and even how to profit from the crisis. But first ... Some Dire Warnings from the Past

Back in the 1930s, when my father and his brothers were beginning their career on Wall Street, the finances of thousands of cities and dozens of states were in shambles. More than $5.5 billion or 30% of their bonds defaulted. Nearly all slashed or even shut down schools, libraries — even police and fire stations. Dad's colleagues on Wall Street had said it could never happen. But it did.
Four decades later, when I was in Brazil in 1970, I saw a similar phenomenon. City budgets were gutted.
Public buildings were sold off to the highest bidder. Public employees and other creditors waiting for up to six months to get paid.

Today those same cities in Brazil are in much better shape. But, unfortunately, we cannot say the same for our cities and states in the United States. Indeed, more recently, when I predicted that rich states like California and New York — plus thousands of cities of all sizes around the country — would suffer a similar crisis ...

Moody's, S&P and Fitch Scoffed and Growled

Moody's, S&P and Fitch are paid huge fees by thousands of state and local governments for giving them ratings that are typically overinflated. They're paid additional fees for rating the insurance companies that supposedly guarantee the municipal bond payments for investors. And then they rake in all those fees year after year simply by maintaining ratings that are often based on grossly outdated data. Now, that municipal bond ratings farce — based on payola and riddled with conflicts of interest — is collapsing for three reasons:

First, it's collapsing because the entire concept of municipal bond insurance — riddled with the same conflicts — has crumbled, just as I warned in The Ultimate Safe Money Guide. Two of the largest bond insurers — Ambac and FGIC — are already bankrupt, with FGIC now subject to possible liquidation by New York State regulators. And MBIA Inc., the only surviving bond insurer among the Big Three, has just been downgraded by three notches to B- — deep into junk territory. Result: Hundreds of thousands of investors who bought insured bonds are now vulnerable. They thought they were buying protection against default. Instead they got little more than a pig in the poke.

Second, it's collapsing because many cities are years behind in providing accurate financial data ... while their finances have deteriorated in a matter of months. Consequently, a large portion of the data is not only grossly outdated ... it's downright wrong, failing to properly reflect the recent sharp deterioration in local finances.

Third, the muni bond ratings farce is collapsing because of the disastrous situation on the ground. Consider these excerpts from 60 Minutes: In the two years since the "great recession" wrecked their economies and shriveled their income, the states have collectively spent nearly a half a trillion dollars more than they collected in taxes. There is also a trillion-dollar hole in their public pension funds. The states have been getting by on billions of dollars in federal stimulus funds, but the day of reckoning is at hand. The debt crisis is already making Wall Street nervous, and some believe that it could derail the recovery, cost a million public employees their jobs and require another big bailout package that no one in Washington wants to talk about. "The most alarming thing about the state issue is the level of complacency," Meredith Whitney, one of the most respected financial analysts on Wall Street and one of the most influential women in American business, told correspondent Steve Kroft. ..."It has tentacles as wide as anything I've seen. I think next to housing this is the single most important issue in the United States, and certainly the largest threat to the U.S. economy."

Next, 60 Minutes provides a rundown of the woes of states. It's shocking. But it barely scratches the surface: California, which faces a $19 billion budget deficit next year, has a credit rating approaching junk status. It now spends more money on public employee pensions than it does on the state university system, which had to increase its tuition by 32 percent. Arizona is so desperate it sold off the state capitol, Supreme Court building and legislative chambers to a group of investors and now leases the buildings from their new owner. The state also eliminated Medicaid funding for most organ transplants.
Then there's New Jersey. It has the highest taxes in the country, a $10 billion deficit and a depressed economy when first-year Governor Chris Christie took office. But after looking at the books, he decided to walk away from a long-planned and much-needed project with New York and the federal government to build a rail tunnel into Manhattan. It would have helped the economy and given employment to 6,000 construction workers. Gov. Christie acknowledged that's a lot of jobs. ... "The bottom line is I don't have the money. And you know what? I can't pay people for those jobs if I don't have the money to pay them. Where am I getting the money? I don't have it. I literally don't have it. ... The day of reckoning has arrived. That's it. And it's gonna arrive everywhere. Timing will vary a little bit, depending upon which state you're in, but it's comin'."