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off the charts

Meredith Whitney’s Wrong Again

Wall Street analyst Meredith Whitney has a new report on state finances, according to Fortune magazine, and, unfortunately, it appears to be just as disconnected from the evidence as her last one.

Whitney predicted last December that, within 12 months, there would be “hundreds of billions of dollars” of defaults in state and local bonds.  The prediction was outlandish — the whole muni bond market is $2.9 trillion, and the few muni bonds that do default each year are almost always very small — and it has shown no sign of coming true.

Here’s a sampling of the errors in her new report, based on our reading of the Fortune story (Whitney’s full analysis is not publicly available).

  • Whitney told Fortune that while state tax revenues went south because of the recent downturn, “spending kept surging all during the recession.”Untrue:  state spending in 2012 is estimated to be 9.4 percent below inflation-adjusted 2008 levels, a drop almost as big as the revenue decline.
  • Whitney asserts that states are using general obligation bonds to help cover their operating costs.Not so:  virtually every dollar of bonds that states and localities sell pays for capital expenses, like construction of roads, bridges, and schools.  Whitney’s claim that the use of those bonds has “immensely increased” is also untrue:  states and localities issued $147 billion in general obligation bonds in 2010, somewhat less than the $153 billion in bonds they issued in 2002, according to Bond Buyer data, adjusted for inflation.
  • Whitney wildly exaggerates what states are spending on interest, claiming for instance that “debt service absorbs half of Nevada’s budget.”Actually, Nevada’s own audited financial report shows that debt service (principal plus interest) is about 4.1 percent of state spending.  Nor is it true that “Fixed interest expenses are absorbing a bigger and bigger share of state budgets”; interest payments have been declining as a share of state and local spending since the mid-1980s, as my colleague Iris J. Lav told Congress earlier this year.
  • Whitney accuses states of “systematically underfunding their pensions” but then contradicts herself by noting that pensions were fully funded before they took a double-hit from the last two recessions.  She also asserts that if states were to fund fully their pension promises, it would cost them 40 percent of their budgets.That’s light-years from the truth.  Boston College’s Center for Retirement Research says that states and localities can fund their pension promises fully if they devote somewhere between 5 and 9 percent of their budgets to employee retirement funds, because they do not have to close their current funding gaps all at once but rather can do so over time.  If states make appropriate reforms to their pension systems, the cost can be even less.

States and localities do have real fiscal problems.  In the short term, revenues are still depressed from the recession.  In the longer term, states have antiquated revenue systems that are inadequate to pay for modern education, health care, public safety, and transportation systems.  They also face rising health care costs, just as private employers and the federal government do, and many need to institute some pension reforms.  The threat, however, is not to the bond market but rather to states’ and communities’ ability to provide needed services.

As Chris Hoene at the National League of Cities pointed out in his critique of Whitney’s “misinformation campaign”:  “Investors should worry less about the risk of systematic collapse of the bond market and instead worry more about whether their local school, police department, or fire hall down the street needs a fundraiser to stay in service.”