The Whitney Recession

Dolors & Sense

by Sanford Rose

KISSIMMEE, FL—(Weekly Hubris)—1/31/11—I thought it was just a museum, but it may be the next recession.

By now, thanks to “60 Minutes,” nearly everyone is talking about Meredith Whitney, the banking guru (she made one good call) who in December of last year predicted on TV some $100 billion to $200 billion in municipal defaults within a year or so.

If Ms. Whitney is right, we’re back in recession—big time.

But is Whitney right?

It probably isn’t relevant. Say something that is initially untrue—thus far in this recession, we’ve only had about $8 billion in defaults—often enough to a big enough audience, and it gradually “becomes” the truth.

And maybe not so gradually. Finance is, after all, a matter of confidence. Undermine that confidence, and things can unravel with incredible speed.

In 2007, we started saying that mortgages were bad. Some of them were, of course. But saying it depressed valuations, which forced banks to call loans, which led to the dumping of securities, which greatly intensified the initial drop in valuations, which caused institutions to go bust, which led to a lot more bad mortgages in 2008 and 2009 than existed in 2007.

Whitney’s remarks helped to set off a selling frenzy in municipals. She can’t take all the credit, by any means. Other factors besides an irresponsible tongue led to a great surplus in the supply of bonds relative to their demand at existing prices.

Prices dutifully fell. And fell. And fell.

In theory, the degringolade creates bargains that entice value-conscious investors back into market. But 70 percent of the traditional owners of municipals are individuals who are not terribly value conscious. They are easily spooked and, not being professionals, hard to “unspook.”

All this means that the municipal market, like the mortgage market in 2008, is perhaps unlikely to recover from its swoon very easily.

States and cities will therefore have to pay a lot more to borrow money in the future than they did in the immediate past.

They are already strapped for funds. And while debt service as a percentage of state revenues currently averages only 4 to 5 percent, it could get bigger. In fact, in a period of slashed budgets, it could become the fastest-growing expenditure item. That increases its visibility and the all-too-human tendency of governments to embrace a quickie fix.

To wit: let’s try default. And at the municipal, as opposed to state, level, let’s try bankruptcy—the now-emerging Vallejo, California model.

Result: the proverbial self-fulfilling prophecy.

The cities default. The states follow—not willingly (states can’t legally declare bankruptcy) but, nevertheless, in actual fact.

A segment of the economy that accounts for 16 percent of the gross domestic product hits the skids.

Voila! The Whitney recession of 2012.