Whitney warns about 'negative feedback loop from hell' in muni market

Says higher taxes will force residents of some states to relocate; where's the revenue going to come from then?

By Jeff Benjamin

Apr 29, 2013 @ 9:05 am (Updated 5:22 pm) EST

Meredith Whitney
(Photo: Bloomberg News)

Investing based on the economic and political realities facing individual U.S. states is offering an “incredible investment advantage,” according to banking analyst Meredith Whitney.

Speaking Sunday evening in Seattle at the start of the Investment Management Consultants Association annual conference, Ms. Whitney explained her December 2010 bearish call on muni bonds by suggesting there are long and short opportunities among individual states.

“You've got some states doing stupid things and some states doing incredible things,” she said. “Unemployment is more than twice as high on the coast as it is in the central corridor states.”

The chief executive of Meredith Whitney Advisory Group LLC has been working on Wall Street for 20 years, but made big news in 2007 with her call that a major financial credit crisis was looming. That call was followed in late 2010 by an even more spectacular call for sweeping municipal bond defaults, which was broadcast during a 60 Minutes interview.

When asked about the negative muni prediction, which rattled the $4 trillion muni bond market and drew a lot of criticism from the bond market, Ms. Whitney said she the reaction surprised her.

“I first published the research from that [December] 60 Minutes interview in September,” she said. “That was an hour and a half interview, and it was not my intention to make any calls on the show, and I didn't expect it to resonate as much as it did.”

As to whether her call on the muni market was premature or exaggerated, she clarified, “I said people would have to worry about it in 12 months because the stimulus money was running out.”

She still isn't backing down on the level of risk she sees in the muni market.

“This is just the beginning, and this stuff will take a long time to play out,” she said. “This is not fun stuff to talk about; the fun stuff to talk about is all the good stuff that governors are doing around the country.”

Along those lines, Ms. Whitney laid out an investment theme that involves digging deep into state and municipal budgets that will tell the story of where and how money is going to be spent over the next few decades.

“People who don't like the taxes in one state will move to another state and that creates the negative feedback loop from hell, and something has got to give,” she said. “The investment side of the issue is the demographic landscape of the United States is changing before our eyes and this is what is important for the next 25 years.”

In terms of what she worries about the most, Ms. Whitney initially paused saying she “didn't want to be audited,” then acknowledged to witnessing “the worst political policies I've ever seen in my lifetime.”

She noted that “the jobs conundrum is not a conundrum, you've got to retrain and relocate people. The lack of political will scares me.”