This reviews the health of the Muni bond market since Meredith Whitney's report of December 19, 2010.

1. Muni bond market: what happened since Meredith Whitney’s December 19, 2010 Report?
Gaetan Lion, April 11, 2012.
Somehow, public finances did not collapse as much as she suggested. We can capture the health
of the Muni bond markets through several indicators, including: 1) the price of Credit Default
Swaps on Munis; 2) the price of one of the largest ETF Muni Bond fund (MUB); 3) the yield on
Munis; and 4) Muni default rates. The dotted vertical lines on those graphs reflect the time
Meredith Whitney (MW) released her report.
First, let’s look at Credit Default Swaps…
MW report essentially captured the
peak of the perceived credit risk in
Munis through high CDS prices at the
end of 2010. Ever since CDS prices
have dropped suggesting a marked
decrease in Munis credit risk for
those 5 large States. Unfortunately
we lack more current data.
Next, let’s look at the price of the ETF Muni Bond fund (MUB).
Price of IShares S&P National Muni Bd. Fd (MUB)
When price of the MUB go up
115
it suggests positive trends in
110 terms of decreasing credit risk,
105 declining related yield, etc…
Again, MW report caught the
100
bottom of the trend as the price
95 of the MUB bottomed out and
90
rapidly rose thereafter.
85
12/14/2007
12/14/2008
12/14/2009
6/14/2010
9/14/2010
12/14/2010
3/14/2011
9/14/2011
12/14/2011
9/14/2007
3/14/2008
6/14/2008
9/14/2008
3/14/2009
6/14/2009
9/14/2009
3/14/2010
6/14/2011
3/14/2012
Let’s look at yields or interest rates on Munis.
1

2. Yield on 20 year Munis Again MW report catches
the trend near the top as
6.0%
Munis yields peak shortly
5.5% after her report comes out.
We could also have looked
5.0%
at spreads between Munis
4.5% and AAA rated corporate
bonds or 10 year Treasuries.
4.0%
But, those spread indicators
3.5% were trendless and not
informative.
3.0%
20 -07
20 -04
20 -07
20 -04
20 -01
20 -10
20 -01
20 -10
20 -07
20 -01
20 -04
20 -10
20 -01
20 -10
20 -01
20 -07
20 -10
20 -04
20 -07
20 -04
20 -07
20 -01
20 -04
20 -10
1
-0
06
06
06
06
07
07
07
07
08
08
08
09
09
09
09
10
10
10
11
11
11
11
12
08
10
20
As noted the first three Muni bond market signals suggest Meredith Whitney was plain wrong
and investors would have profited from doing the opposite of her recommendation. But, the
situation gets muddled when we look at Muni bond default rate next…
Muni Defaults as a % of outstandings
0.8%
0.7%
0.6%
0.5%
0.4%
0.3%
0.2%
0.1%
0.0%
90
91
92
93
94
98
99
00
01
02
03
04
05
06
95
96
97
07
08
09
10
11
19
19
19
20
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
20
20
Sources: Distressed Debt Securities Newsletter and Putnam Investments.
Muni default rates more than tripled after Meredith Whitney’s report suggesting that her call was
correct. Yet, keep in mind such default rates are still low. Munis default rates at all equivalent
bond ratings are far lower than corporate bond default rates. And, recoveries after default are a
lot higher than for corporate bonds (65% vs 49% Epoch time article 4/05/2012). Thus, Meredith
Whitney was directionally correct. But, her call was too Cassandra like as she projected a level
of $ default that was much higher than what ultimately occurred.
2

3. How did the Muni bond market avoid the apocalypse foreseen by Meredith Whitney?
In January 2011, Vanguard issued a rebutting report called “California is not Greece” just a
couple of weeks after Meredith Whitney. Vanguard conveyed that the Muni bond market was
more resilient due to structural factors that MW ignored such as:
• The vast majority of Munis have long term maturities associated with self-amortizing
debt service of over 20 years. Thus, refinancing risk is low and gives public entities
time to get their fiscal affairs in order.
• State-level debt burden is modest as a % of gross state product, averaging less than
2.8% nationwide with Massachusetts being the most indebted State with a ratio of
only 8.3% (around the same time the US ratio was close to 70% and Greece probably
over 200%).
• Given the States’ low debt ratio, bond default represents a negative trade off
including being shut out of the capital markets. Yet States do need financing.
• Individual investors (directly or through bond funds) hold nearly 70% of Munis. For
a State or a municipality to default and hurt its own taxpayers and voters is not a
good idea. By the same token, individual investors being the major Muni bond
investors reduce the systemic risk of Muni bonds.
Is all well in the Muni bond market?
No, it is not. The same Vanguard report mentioned the Pension crisis citing that pension and
retirement health care plans were grossly underfunded to the tune of $1 trillion. The financial
crisis aftermath including depressed housing prices did hurt local government revenues through
declining sales and property tax receipts. Yet, social transfer payments have increased local
government expenditures.
Municipal bond defaults, although rare, are at a record high since 1990 as shown earlier. Several
California cities and municipalities are struggling to meet their pension obligation and debt
service requirements including Stockton, Vallejo, San Jose, and Hercules. Other municipalities
in other States are also struggling for the same reasons.
Detroit is in near fiscal limbo. The future of its local governance is highly uncertain as it may be
affected by Michigan’s Financial Emergency Law whereby when a local government is unable to
shore up its fiscal situation, the State appoints a team of Financial Emergency Managers that take
over. The rest of the States are watching Michigan’s law to see how effective it is and how
related constitutional and political challenges develop.
3