The Muni-Meltdown That Wasn't

The MUNI-MELTDOWN
THAT WASN’T.
November 2014
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11.25.14 www.bloombergbriefs.com Bloomberg Brief | Muni Meltdown 2
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MUNI MANIA: A TIMELINE
FEBRUARY 2009
“If a few communities stiff their creditors
and get away with it, the chance that oth-ers
will follow in their footsteps will grow.”
– Warren Buffett APRIL 2009
Moody’s assigns the U.S. Local Govern-ment
Sector a negative outlook
SEPTEMBER 29, 2009
“Dark Vision: The Coming Collapse of the
Municipal Bond Market”
– Frederick J. Sheehan, published
by Weeden & Co.
DECEMBER 2009
“Are State Public Pensions Sustainable?”
– Joshua D. Rauh
MARCH 30, 2010
“State Debt Woes Grow
Too Big to Camouflage”
– The New York Times APRIL 4, 2010
“Once a few municipalities default, there is
a risk of a widespread cascade in defaults.”
APRIL 15, 2010 – Richard Bookstaber, blog
“This isn’t capitalism. It’s nomadic thievery.”
– “Looting Main Street,” by Matt Taibbi, Rolling Stone
SPRING 2010
“Beware the Muni Bond Bubble: Inves-tors
are kidding themselves if they
think that states and cities can’t fail.”
– Nicole Gelinas, City Journal
SUMMER 2010
“How to Dismantle a
Muni-Bond Bomb”
– Steven Malanga, City Journal
SEPTEMBER 2010
“The Tragedy of the Commons”
– Meredith Whitney
OCTOBER 5, 2010
“Cities in Debt Turn to States,
Adding Strain”
– The New York Times
NOVEMBER 16, 2010
“California will default
on its debt.”
– Chris Whalen to Business Insider
NOVEMBER 29, 2010
“Give States a Way to
Go Bankrupt”
– David Skeel, The Weekly Standard
DECEMBER 5, 2010
“Mounting Debts by States
Stoke Fears of Crisis”
– The New York Times
DECEMBER 19, 2010 “Hundreds
of billions”
– Meredith Whitney, on 60 Minutes
DECEMBER 24, 2010:
“I can’t make the numbers work. If you look at the 10 largest
cities and the 25 largest counties in the country, that’s $114 bil-lion
in debt outstanding. So you gotta basically have New York,
Chicago, Phoenix, Los Angeles — these cities start to default.”
– Ben Thompson, Samson Capital, on CNBC
JANUARY 20, 2011:
“Misunderstandings Regarding State Debt, Pensions,
and Retiree Health Costs Create Unnecessary Alarm”
– Center on Budget and Policy Priorities 21-page white paper AUGUST 2011:
“[I don’t care about the] “stinkin’ municipal bond market.”
– Meredith Whitney to Michael Lewis

INTRO
An old-media kind of guy, I still keep file folders of stories, blog
entries, clippings, messages and reports printed out and more or
less sorted. Back in early 2009, I started a file labeled “Hysteria’’
to hold the physical evidence of what I thought the most unusual
and even outlandish claims being leveled against an asset class I
have spent 33 years writing about — municipal bonds.
Over the next couple of years, the file swelled. I started another. And another. I didn’t
even include Meredith Whitney. She got an entire file of her own.
I collected so much material that I decided to use it as a presentation to the Bond At-torneys
Winter Workshop one year. Even then I only got to use the high-points, or low
points, if you prefer, entering each exhibit into evidence. I considered this clever.
“Show me a revenue stream and I’ll show you a bond issue,” is an old banker’s axiom.
The writer’s equivalent is probably, “Show me a box of research and I’ll show you a book.”
Or, in this case, a special supplement. And so here we are.
In 2010, municipal bonds, hitherto known only as secure, boring investments, if some-times
a little weird, were front-page news. It was stated with some confidence that the
entire market was going to go bust.
Of the Great Municipal Market Meltdown – so confidently predicted for 2010, 2011, 2012,
and so on – I think we are now finally able to say, “That didn’t happen.” As it was being
predicted, I observed that the reason it wasn’t happening was because “that doesn’t hap-pen.”
In other words, the various “experts’’ then weighing in about state and local govern-ments’
coming mass insolvency and/or repudiation didn’t know what they were talking
about. That didn’t stop what I termed their “Inexpert Testimony” from being offered. And
widely (and unfairly, I thought) quoted.
I define “meltdown’’ here as its proponents did: widespread default or outright repudiation
of municipal bonds. There were a number of (non-muni) analysts and observers eager to
forecast just this possibility. Others contented themselves with stoking hysteria in regard
to public pensions. One even expressed outrage over Wall Street’s underwriting and
banking relations with Main Street borrowers. The blowup to come, we were assured,
was going to be almost operatic.
The more I leafed through these bulging files — in retrospect, and recollected in tranquil-ity,
as the poet says — the more I asked, How did this come about? Why were so many
people who were little more than tourists in MuniLand taken so seriously?
Why was the opinion of those who did know what they were talking about so heav-ily
discounted? What lessons can investors learn from this? Because lots of investors,
especially after Meredith Whitney made her famous call on “60 Minutes” in December
of 2010, sold both muni mutual fund shares and individual bonds, sometimes at fire-sale
prices. They wanted to get out at any price. Panic was in the air.
There’s no one answer. There are lots of answers.
Inside
In the Beginning
Particular and Specific......................5
The Undiscovered Country
Just Look!..........................................8
The End of Something
Splendid Isolation No More...............9
‘Dark Vision’
Bombs Away...................................10
The Coming Collapse
In Sum.............................................11
Into the Abyss
‘Dump Munis’...................................12
Public Pensions
We Have a Problem.........................13
Media Frenzy
Everyone’s Meltdown.......................16
The Market Responds to Its Critics
First Responders.............................19
Oh, Meredith
‘Hundreds of Billions’.......................23
After ‘Hundreds of Billions’
Victory Lap......................................24
Returning Fire
That’s Enough!.................................26
What Happened, Lessons Learned
Age of Twitter...................................27
Appendixes
To the Foregoing Work....................30
There’s no one answer.
There are lots of answers.

I: In the Beginning
Faced with Wall Street firms going bust,
mass firings, the housing price collapse
and 401(k) plans evaporating as the stock
market plummeted, it was hard for munici-pal
bonds to make the front page.
They tried. Two events in particular had
rocked munis in 2008. In February, the
$330 billion auction-rate securities market
froze after Wall Street banks stopped
providing backstop bids for the stuff. The
market had long relied on a convention
the Street could no longer afford – instant
liquidity. The result: Investors in many
auction issues could see their money, but
couldn’t lay their hands on it. It would take
years to remedy the situation.
Rise of the Insurers
This was damaging enough to the mar-ket’s
psyche. Even worse was the down-grade
of most of the AAA-rated municipal
bond insurers. Bond insurance was per-haps
the most successful franchise in the
municipal bond market, originating in 1971
and reaching a peak penetration of 57
percent of the new issue market by 2005.
Bond insurance was also the thing that
“commoditized’’ the market. No longer did
investors have to study the innumerable
details of a bond issue’s structure and
security. Now there was just this thing you
could buy called a municipal bond that
produced interest that was tax-exempt and
that was incredibly safe and secure in the
first place and was now even insured as to
repayment of principal and interest and so
rated AAA. Or so it was thought for a very
brief period stretching from perhaps 1985
to the collapse of the insurers in 2008.
The insurers had proven to be in the
right place at the right time. They were
even, helpfully, a little early. States and
municipalities were just about to embark
on a borrowing binge, spurred in part
by the threat, real and imagined, of tax
reform that would prohibit them from
financing certain things with tax-exempt
securities, and then by a decline in inter-est
rates that sparked a wave of refinanc-ing,
and finally by a boom in what we may
term bankerly creativity. I’m sure the rise
of suburbs beyond the suburbs and their
concomitant needs for infrastructure like
streets and sewers and schools was part
of it, as was the later urban renaissance.
Analysts could take cold comfort in the
fact that the insurers didn’t lose their AAA
ratings because of anything they’d done
in the municipal market. Their sin was
expanding into asset-backed securities,
a move inspired as much by stockholder
interest in returns as demanded (well,
almost) by the ratings companies, which
urged the insurers to expand into more
lucrative areas of business.
And here it might be appropriate to say
why commoditization was so welcomed in
this market. As investor Paul Isaac once
put it to me over cocktails, “So what you’re
saying is, municipal bonds are particular
and specific to a remarkable degree.’’
Isaac was responding to my amaze-ment
and frustration trying to understand
a subject that seemed endless and
unfathomable. This was back in the early
1980s. I stole his phrase and have used it
ever since, only occasionally substituting
“insane’’ for “remarkable.’’
This turned out to be the single most
important observation about municipal
bonds I have ever heard. It explains so
much. It explains everything.
The multifarious (“of great variety;
diverse’’ according to Webster’s) nature
of municipal bonds is one of the reasons
I became so convinced that a national
meltdown was unlikely. We’re not talking
about dozens or scores of issuers, but
tens of thousands.
The Census of Governments done by
the U.S. Census Bureau every seven
years shows that there are just over
90,000 governmental entities in the U.S. It
has been estimated by the Municipal Se-curities
Rulemaking Board, the market’s
self-regulatory organization, that perhaps
50,000 have borrowed money in the mu-nicipal
market at some time or other.
They have done so with serial and term
bonds, with notes, with variable- and the
aforementioned auction-rate securities,
using their full-faith and credit taxing
power pledge, their limited taxing power
pledge, their mere promise to appropriate
money for debt service, and more often
than not (since the 1970s), with the prom-ise
of specific revenue streams. And did I
mention the companies, like airlines, that
also borrow in the municipal market?
Sucker’s Bet
In fact, it’s a rare government that uses
its general obligation, full-faith and credit
pledge to sell bonds to borrow money.
What was once termed the shadow gov-ernment,
and not in an approving way, is
the primary engine of borrowing in today’s
continued on next page...
Source: Nick Ferris/Bloomberg
Joe Mysak
Our story begins in 2009. There may have been hysterical commentary
about the condition of the municipal bond market before this. There
probably was; I just don’t recall it. Maybe it lacked a certain intellectual
heft, and so had little impact on me as I read it. More likely, it was sub-merged
in the round-the-clock hysteria then surrounding nothing less
than the state of capitalism in the free world. The recession that had
begun in late 2007 and accelerated in 2008 still had a way to go.

continued from previous page...
muni market: a network of districts, agen-cies,
authorities and public corporations,
staffed by their own professionals and
insulated, if you will, from the public and
even from duly-elected government of-ficials,
like a city council, for example. The
decentralized nature of municipal issu-ance
turns out to be one of the market’s
great strengths.
Add to this the perpetual nature of most
governmental entities and you can see
why a mass municipal meltdown was a
sucker’s bet. Perhaps only someone who
has looked through 12 or 20 screens of
a Bloomberg terminal’s “Municipal Bond
Ticker Look Up’’ can appreciate this. Type
in a name of a municipal issuer and you
get screen after screen of apparent direct
relations. Who are all these guys? The
auction-rate freezeout and the collapse of
the bond insurers were stunning stories,
unimaginable for anyone familiar with the
things, yet in the context of the times in
2008 just more collateral damage from the
subprime mortgage implosion.
More bad news was on the way in 2009,
as the recession deepened and states
and municipalities saw tax revenue dwin-dle.
The recession officially ended in June
of 2009. State tax collections declined
versus the same period the previous year
in every quarter from the fourth quarter
of 2008 to the fourth quarter of 2009,
according to the Nelson A. Rockefeller
Institute of Government.
That’s another feature of the municipal
market; state and local government isn’t
on the front end of recession, but on the
tail. Public finance is a lagging indicator.
This is why most states and municipali-ties
were still hiring in 2008, even as the
private sector was shedding hundreds of
thousands of jobs.
Acronym Mad
Now we come to the first major market
“call’’ that attracted my attention as be-ing
a little exaggerated if not hysterical.
Because, let’s face it, Warren Buffett is
no hysteric.
The reference to munis came in the
February 2009 edition of the letter Buffett
sends annually to Berkshire Hathaway
shareholders. Berkshire had launched
Berkshire Hathaway Assurance Company
(or BHAC: the bond insurance business
is acronym-mad) in 2008 as a municipal
bond insurer. Under a section of his letter
entitled, Tax-Exempt Bond Insurance,
Buffett recounted BHAC’s year, which at
one point included an offer to reinsure the
other largest monoline municipal bond
insurers’ existing books of business. The
insurers rebuffed the offer.
Buffett said BHAC would “remain very
cautious about the business we write and
regard it as far from a sure thing that this
insurance will ultimately be profitable for
us. The reason is simple, though I have
never seen even a passing reference to it
by any financial analyst, rating agency or
monoline CEO,’’ Buffett wrote.
He continued, “The rationale behind
very low premium rates for insuring
tax-exempts has been that the defaults
have historically been few. But that record
largely reflects the experience of entities
that issued uninsured bonds. Insurance of
tax-exempt bonds didn’t exist before 1971,
and even after that most bonds remained
uninsured.’’
Buffett continued: “A universe of tax-ex-empts
fully covered by insurance would be
certain to have a somewhat different loss
experience from a group of uninsured, but
otherwise similar bonds, the only question
being how different. To understand why,
let’s go back to 1975 when New York City
was on the edge of bankruptcy. At the time
its bonds — virtually all uninsured — were
heavily held by the city’s wealthier resi-dents
as well as by New York banks and
other institutions. These local bondholders
deeply desired to solve the city’s fiscal
problems. So before long, concessions
and cooperation from a host of involved
constituencies produced a solution. With-out
one, it was apparent to all that New
York’s citizens and businesses would have
experienced widespread and severe finan-cial
losses from their bond holdings.’’
If, Buffett posited, all of the city’s bonds
were insured by Berkshire, would “simi-lar
belt-tightening, tax increases, labor
concessions, etc.’’ have been forthcom-ing?
Of course not, he answered. “At a
minimum, Berkshire would have been
asked to ‘share’ the required sacrifices.
And, considering our deep pockets, the
required contribution would most certainly
have been substantial.’’
In other words, the city would have
defaulted on its insured bonds, leaving
the insurer to pay the debt service. At
some point, it is assumed, the city and the
insurer would sit down and negotiate the
terms of repayment, but not in full.
‘Simply Staggering’
Buffett observed that local governments
were going to face far tougher fiscal prob-lems
in the future. “The pension liabilities I
talked about in last year’s report will be a
“If a few communities stiff their
creditors and get away with it, the
chance that others will follow in
their footsteps will grow.” — Warren Buffett

huge contributor to these woes. Many cit-ies
and states were surely horrified when
they inspected the status of their funding
at year-end 2008. The gap between as-sets
and a realistic actuarial valuation of
present liabilities is simply staggering.’’
So far, so good. New York City’s near-miss
with bankruptcy, I know, was a close-run
thing, with the state playing a powerful
role in the rescue, along with the United
Federation of Teachers.
Buffett’s theory of the role insurers
might play in a meltdown was somewhat
prescient, as the Detroit bankruptcy has
shown us: the insurers have a seat at the
table, and are indeed expected to “contrib-ute’’
to Detroit’s future, by taking less than
they are owed by the city.
Buffett’s concerns about public pensions
were nothing new or astonishing. Numer-ous
analysts pointed out how they had suf-fered
after the tech bubble burst only a few
years before. (It is worth noting, however,
that in 2000, the so-called funding ratios of
public pensions topped 100 percent).
And then Buffett went just a little bit further.
“When faced with large revenue short-falls,
communities that have all of their
bonds insured will be more prone to
develop ‘solutions’ less favorable to bond-holders
than those communities that have
uninsured bonds held by local banks and
residents. Losses in the tax-exempt arena,
when they come, are also likely to be
“Municipa l bonds are
particular and specific to
a remarkable degree.”
– Paul Isaac, Investor
highly correlated among issuers.’’
This last sentence can be parsed any
number of ways, and I’m not going to at-tempt
it here.
But then, this: “If a few communities stiff
their creditors and get away with it, the
chance that others will follow in their foot-steps
will grow. What mayor or city council
is going to choose pain to local citizens in
the form of major tax increases over pain
to a far-away bond insurer?’’
Buffett concluded that insuring mu-nicipal
bonds “has the look today of a
dangerous business.’’
The headline words were “dangerous
business.’’ The real story was in the previ-ous
two sentences, about 1) a seeming
contagion in municipalities
actively seeking to stiff their creditors and
“get away with it,’’ and 2) elected officials
choosing not to make some very hard
choices.
I didn’t know it at the time, of course, but
the Buffett letter was the first salvo in what
would become a muni meltdown barrage.
At the time, I thought it interesting, purely
because munis were so unremarked upon
in general. I also thought it a trifle over-wrought,
said so in a column, and was
surprised at how many e-mails I received
from the Great Man’s minions, eager to
denounce unbelievers. Much worse was
to come.

II: The Undiscovered Country
Source: Bloomberg/Daniel Acker
Warren Buffett
In 2008, Buffett made his overtures to
the beleaguered bond insurers. The pos-sibility
that they might lose their top credit
ratings was already a hot topic of con-versation
among market participants, not
least because investor Bill Ackman was
shorting the stock of the biggest insurer,
MBIA, and he made sure the Wall Street
Journal knew it.
But there were a lot of other things being
discussed in the municipal market, as
well. How would a decline in tax revenue
affect budgets and credit ratings? How
would states and municipalities deal with
stock market losses that had blown a hole
in the value of the assets they had put
away to cover pension liabilities? Could
they manage the expense of “Other Post-
Employment Benefits,’’ previously handled
mainly as a pay-as-you-go expense?
Then there was the SEC’s ongoing in-vestigation
into bid-rigging and price-fixing
in the municipal reinvestment business,
the whole murky world that exists after
issuers sell bonds and need to invest the
proceeds. The use and proliferation and
opacity of swaps was finally getting some
attention, too.
There wasn’t a lot of big press coverage of
municipal finance because editors found
the topic almost stupefyingly dull.
Everybody’s Talking
The Municipal Securities Rulemaking
Board, for its part, was in the midst of a
push to reform disclosure and enhance
price transparency, as well as regulat-ing
municipal advisers and establishing
who owed issuers fiduciary responsibility,
among other things.
Yes, all of these topics were being dis-cussed
in the muni market. Just because
these subjects only sporadically appeared
in the major newspapers and almost
never made it to television and cable news
doesn’t mean that they weren’t being
talked about, and covered by local news-papers
and the very specialized financial
press, that write about munis. There was
a lot of ferment going on in municipals in
the 2000s.
And yet, a common claim among those
who would stoke the muni meltdown
hysteria was that “nobody’s talking about
this,’’ as if an almost $3 trillion market (at
the time) was somehow being conducted
entirely in secret — and I have been a
critic of how private public finance can
sometimes be.
Or they would claim, “the experts’’ (who-ever
these people were supposed to be;
perhaps even I was one of them) were so
conflicted that they couldn’t possibly see
this or that self-evident truth.
The other side of the argument, of
course, is that nobody was talking about
“it’’ (whatever it happens to be), because
“it’’ isn’t true.
The mainstream media, as they call it
nowadays, has always had a problem with
the municipal market. Municipal bonds
are hard to understand. Bankers and the
many financial professionals who assist
public officials in their bond sales tend to
follow a code of silence. The sales and
trading of municipals is done over the
counter, almost on a bespoke basis.
The press loves a simple story, and
public finance is extremely nuanced. The
relatively high cost of entry for investors
(you need tens of thousands of dollars
to invest in munis, a few hundred to buy
stocks) means that municipal bonds aren’t
really even part of the financial “culture,’’ in
the way that stocks are.
Tourists in MuniLand
There wasn’t a lot of what I’ll call big
press coverage of municipal finance be-cause
editors found the topic stupefyingly
dull and so, they reasoned, few people
would care to read about it. I sometimes
think I would have had more readers if I
wrote about Hummel figurines, or numis-matics,
rather than munis.
Beginning in 2009, more people were
claiming that the municipal market was
the undiscovered country. Just look at
what we’ve found, these critics — tourists
in MuniLand — would say. And, no sur-prise,
the story they so often brought back
was very similar to the stories that tourists
tell: by turns frightening and amusing, and
of limited long-term value.
Never had so many been so misled by
so few with such little actual expertise.

III: The End of Something
The municipal market’s long period of
splendid isolation, if we can call it that,
was all about to end. The story of the
market meltdown that wasn’t is very much
a story of the media.
To repeat: Nobody was saying that
states and municipalities were not facing
some pretty stiff headwinds as a result of
the real estate bubble and recession.
What made this time different is that
house price declines played out nationally
rather than, as is usual, regionally. There
were of course some markets that fared
much better than others, but prices fell
everywhere.
In April 2009, Moody’s assigned a
negative outlook to the U.S. Local Gov-ernment
Sector, saying, “This is the first
time we have assigned an outlook to this
extremely large and diverse sector. This
negative outlook reflects the significant
fiscal challenges local governments face
as a result of the housing market collapse,
dislocations in the financial markets, and
a recession that is broader and deeper
than any recent downturn.’’
Note the language: “significant fiscal
challenges.’’
I had long been a fan of the restrained,
sober style the analysts at the rating com-panies
had learned to use (it was, I was
informed, very much a learned style). If
you were unaccustomed to the style, you
could read through thousands of words of
analysts’ prose and not quite know what
they were really saying, or if they were
saying anything at all.
Not this time. The company continued,
“Sharply falling property values, contract-ing
consumer spending, job losses, and
limited credit availability lead the long list
of developments that will make balancing
budgets in the coming year particularly
difficult. The negative outlook assigned to
the U.S. local government sector en-capsulates
our view on this challenging
environment and the strains that will be
evident in credit for issuers across the
industry.’’
This was a very well-crafted, detailed
piece of work in nine pages. I was im-pressed
by the – for them – blunt tone as
well as the way it reminded its readers
that this was a big market, particular and
specific to a remarkable degree, in the
words of my friend Isaac.
Again, Moody’s: “Credit pressures faced
by local governments and their responses
to these pressures will vary significantly
across and within states due to uneven
economic conditions, differing revenue
mixes and service mandates, inconsistent
property assessment practices, and differ-ent
levels of revenue raising authority. The
governance strength of individual issuers
and behaviors which demonstrates their
willingness and ability to adapt to that en-vironment
will determine the overall trend
in individual ratings.’’
The rating company put the entire sector
on negative outlook. It didn’t say that the
entire sector would respond in the same
way to the extraordinary, “unprecedented’’
pressures then accumulating: unemploy-ment
at more than 8 percent, stock prices
off 50 percent, home prices down an aver-age
25 percent from their peak. And what
might be the result? “Increased rating
revisions’’ for local governments.
This was an extremely reasonable, clear
piece of work from a generally recog-nized
authority on the subject. Unhappily,
because of their role in the subprime
mortgage collapse, the rating companies in
general had forfeited a certain credibility by
this point, even in the municipal market.
An earlier announcement by Moody’s in
March of 2007 that it would stop using a
dual scale to rate municipalities and cor-porations
had touched off a controversy
that once would have dominated market
conversation. Now, in the midst of the
recession, it was almost an afterthought.
Moody’s and Fitch finally recalibrated
their ratings in 2010; Standard & Poor’s
announced a change in its own methodol-ogy
for rating municipalities soon after.
Looking back at 2009, I am surprised by
just what a newsy year it was in munici-pals.
Jefferson County, Alabama, was still
trying to avoid bankruptcy. Municipali-ties
were starting to file lawsuits against
those Wall Street firms that had sold them
swaps and derivatives.
In August, the MSRB said it was looking
at “flipping’’ in the muni market, apparent
in glaring fashion soon after states and
municipalities started selling federally-subsidized
Build America Bonds.
A federal grand jury would finally indict
CDR Financial Products, the firm at the
red-hot center of the market’s bid-rigging
scandal, at the end of October.
There was a time I used the expres-sion
“bullets don’t grow on trees’’ from the
movie “Michael Collins,’’ to characterize
actual municipal market news, and to cau-tion
reporters to husband story ideas with
care. No longer. In 2009, it seemed like
news was breaking every day.
Then one day in October, I got an e-mail
from a reader. His name was familiar to
me as someone who occasionally com-mented
on my columns. He attached a
report that he said he found compelling.
“This is the first time we have
assigned an outlook to this large
and diverse sector.”
— Moody’s

IV: ‘Dark Vision’
I wish I saved that first e-mail, so I could
give proper credit to the sender. In the
weeks to come, more correspondents
would forward me the same report, most
accompanied by a message written in a
tone of resignation and dismay. One even
sent me a copy in the mail. People wanted
to make sure I saw this thing
The report was “Dark Vision: The
Coming Collapse of the Municipal Bond
Market,’’ published by Weeden & Co. for
its clients. It was a “guest perspective’’ as
they called it, by Frederick J. Sheehan.
This was the first piece I had ever seen to
call for the municipal market’s imminent
meltdown. It was also the first piece to
demonstrate to me that the muni market
was entering a new media age.
I originally dismissed it. I glanced at that
title, winced, and put it aside. Weeden &
Co.? They weren’t in the municipal market.
Frederick J. Sheehan? Who was he? I
hadn’t seen him on the muni beat before.
“The Coming Collapse of the Municipal
Bond Market’’? Please.
It really wasn’t until I spotted it again, this
time in a reference to a business blog on
yet another financial news web site, that I
realized that the market had a problem. In
the new Internet age, anyone could write
anything and it could achieve the credibil-ity
and authority of “publication.’’
Anything Goes
And it metastasized. An article or report
was no longer published once, but again,
and again, and again, all over the Internet.
The new reporters, or editors, or whatever
you called them, sometimes did no more
than put an inviting and often sensational
headline on a short summary, and then
provide a link to the actual underlying
document, story, report, lawsuit, opinion
piece, whatever it happened to be. And
then dozens or scores of readers could
comment on it, further legitimizing the story,
no matter how inane their own commentary.
In the new Internet age, anyone could write
anything, and it could achieve the
credibility and authority of ‘publication.’
In this publication democracy, it seemed,
everything was valid, all points of view le-gitimate.
It would take some time, for me,
to realize that the key thing in this transac-tion
was for the author to say something,
usually bad, was going to occur, and very
soon. This seemed to be the only criterion
for the new “publication’’ world: Some-thing
Bad Is Going To Happen. This got
you clicks, this got you viewers, this got
you subscribers, this got you on televi-sion,
and, in some cases, it got you book
contracts.
In fact, more often than not, in public
finance as in most people’s lives: Nothing
happens. Things muddle along, things
work out, or not, in slow and usually
unspectacular fashion. Especially, might I
add, in the municipal bond market, where
trading in a new issue typically ceases
after about 30 days, and where time is
measured with a calendar.
“The Coming Collapse of the Municipal
Bond Market’’? The timing of this piece
was propitious. The Great Recession,
it seemed, had just ended in June, but
people were still ready to believe anything
about everything. “The Coming Collapse
of the Municipal Bond Market’’? Why not?
Hysteria Begins
“Dark Vision’’ was dated Sept. 29, 2009.
This is when I date the kickoff of the Muni
Market Meltdown Hysteria. So many
things came together at this precise mo-ment:
the rise of the Internet; the explo-sion
of business and financial news web
sites (it is worth noting that Business
Insider only began in 2007); more cable
business coverage; the greatest reces-sion
since the Great Depression; the 24/7
news cycle.
Only a few years later, I suspect, any
such “meltdown’’ call would have been
mitigated, even refuted, by the very same
Internet that had given birth to it. Twitter
would kill it.
But in 2009, most of those who knew
anything about the municipal market
weren’t tweeting. “Bond Girl,’’ for example,
didn’t start tweeting until April of 2011,
Reuters’ Muniland blogger Cate Long in
July of 2010.
Inexpert testimony was set for a very
brief reign in the muni world.
FOLLOW JOE MYSAK ON TWITTER >>>>
FOR REGULAR UPDATES AND ADDITIONAL INSIGHTS @joemysak

V: The Coming Collapse of the Municipal Bond Market
The most remarkable part of “Dark Vision’’
was the title and subhead. For the uninitiated,
“Dark Vision’’ looked plausible enough, with
various bits of data and almost two pages of
scholarly-looking footnotes. The more I read
it and considered it, the more I realized it was
little more than a series of assertions, without
a lot of proof.
The author had written a couple of books
critical of Alan Greenspan and the Fed-eral
Reserve, according to the identifying
note attached to the piece. I got the feeling,
as I was reading, that he was grinding a
libertarian axe. Political point of view and
credit analysis usually don’t mix well.
I don’t want to spend too much time on
“Dark Vision,’’ which I found unpersuasive, so
let me try and summarize.
It is time to get out of municipal bonds,
says Sheehan. They are now to be considered
speculative investments, and buyers are just
not being compensated enough for the risk
they are taking. Fair enough, I thought.
“The municipal market will probably repeat
the pattern of the sub-prime collapse,’’ he
wrote. “Although it is plain to see, the usual
experts do not notice.’’ He doesn’t say who
these experts are, although I infer that they
are the rating companies.
He describes the “mess’’ in public finance:
“Recent cost-cutting by states and munici-palities
is inadequate. This much is prob-ably
obvious. What may go unrecognized
is that filling these gaps using conventional
measures is impossible. Parties to suffer
from unconventional measures include
bondholders.’’
This pretty much sums up the Sheehan
argument. States and municipalities spend
too much, borrow too much, promise too
much to their employees. Faced with the
“impossible,’’ many municipalities will seek
bankruptcy court protection.
Bondholders can’t rely on issuers’ pledg-es
to levy taxes to pay debt service. Nor
can they trust that the courts will ensure
that they are paid.
Had Sheehan limited his remarks to “De-troit,’’
I might have hailed him as a visionary
today. Had he somehow limited his thesis
to “some’’ or even “a handful’’ of municipali-ties,
even that would have been somewhat
acceptable. But no. The entire market will
“collapse.’’ On the other hand, who wants
to publish “The Coming Collapse of an In-finitesimal
Number of Municipalities’’? Who
would read it, beside the hard core?
That all states had borrowed too much
was a typical canard. Taking a look at
Moody’s annual State Debt Medians Re-port
published in July of 2009, the author
could have seen that net tax-supported
debt per capita drops fairly quickly after
you look at the top 10 states. In first place
was Connecticut, at $4,490; in 10th was
California, at $1,805. In 30 of the states,
the figure was below $1,000.
A similar story could be told about public
pensions, as well as public employee pay.
A few states were bad at making their
actuarially-required contributions to their
pension systems. Some states and cities
had sweetened pensions, and salaries,
without much apparent regard of how to
pay for them.
And then there were some errors:
“Current bond issues will need to be
rolled over when they mature, since
budget gaps are rising.’’ Sheehan takes a
hallmark of the sovereign debt market and
transfers it to munis. That’s not how munis
work. Municipalities pay off their debts
over time, usually through the use of
serially maturing bonds. Yet this “rollover’’
error would be repeated.
Note here that Sheehan wasn’t talking
about the letters of credit or liquidity facili-ties
backing variable-rate demand obliga-tions
expiring. This would become one of
the market’s typical non-issue issues in
2010 and 2011. As it turned out, the market
handled the, in Moody’s words, “unprec-edented’’
number of expirations handily.
Sheehan wasn’t talking about VRDOs. He
was describing “the next Greece,’’ as critics
of the time put it.
“One of the largest municipal expendi-tures
is coupon interest on bond obliga-tions.’’
That’s not true. Debt service is
actually one of the smaller items in most
municipal budgets. As analysts would
eventually point out, why would public
officials go out of their way to anger the
investors they need and target debt ser-vice,
since it would be of so little help in a
financial emergency?
Why did I go back and read “Dark Vi-sion’’?
Because more than a month after
it was published, it was mentioned on a
business news web site, which linked to
a piece on the Seeking Alpha blog, which
in turn linked to a piece on a Harvard Law
School blog, picking up approving com-ments
from the uninformed every step of
the way.
And so the “coming collapse’’ of the mu-nicipal
bond market had been announced.
In 2011, Bloomberg Brief: Municipal
Market’s Brian Chappatta asked Sheehan
what happened — why hadn’t the market
collapsed? He gave a very detailed re-sponse,
which I include here as Appendix
2. I called him on Nov. 17 of this year, and
he gave me a very similar response: “One
thing I didn’t understand was how hard
states would work to pay their bonds so
they could continue to legislate. I thought
there’d be much more of a battle between
paying bonds and other expenses like
pensions. I still think that has to come at
some point, as the asset price bubble
starts to deflate. [States and municipali-ties]
have continued to spend as if they
learned nothing from how close they did
come to defaulting in 2009.’’
Source: Bloomberg/Andrew Harrer
Alan Greenspan

VI: Into The Abyss
The crush of news in 2009 meant that it
took a while for the market to confront the
municipal bond meltdown scenario being
presented. The Sheehan piece achieved
what I sensed was wide circulation, show-ing
up around the Internet without much in
the way of rebuttal.
Sheehan was first. James Chanos,
noted short-seller, appeared in Barron’s
in the Nov. 9 “Current Yield’’ column:
“Dump Munis,’’ was the headline. The
culprit: “platinum-plated health-care and
retirement benefits,’’ said Chanos. I asked
Chanos on Nov. 17 if he had any further
thoughts about the municipal market, and
he declined comment.
On Dec. 16, 2009, Standard & Poor’s
published a paper entitled “Credit FAQ:
The Recession’s Impact on U.S. State and
Local Government Credit Risk.’’
I now see this as the first defense of
munis. Whether it was done in response
to Sheehan, I do not know.
The FAQ format is, of course, a feature
of the Internet; I’m not sure how much
circulation this piece got. It was detailed
and reasonable and accurate. But of
course Collapse trumps Muddle Along in
the Internet popularity stakes.
My favorite answer came in response
to the question: “Then why do state and
local governments keep talking about the
dire straits they are in?’’ S&P said: “As this
all plays out, we think that new headlines
will likely capture elected officials’ and oth-ers’
efforts to make the public aware of the
circumstances of their austerity measures
and what they think will be the conse-quences
of inaction.’’
Do the Right Thing
The important thing about the S&P
piece, as well as the earlier Moody’s
commentary tagging the entire sector with
a negative outlook, was that both rating
companies expected most public officials
to do the right thing by their bondholders.
Also noteworthy, especially in retrospect,
is how S&P took pains to say how “condi-tions
do vary.’’ Once again: particular and
specific. It’s very much like that old legal
expression: all facts and circumstances.
Even in 2009, you could see several
themes playing out here. On the one
hand, you had outside critics saying that
municipalities were all in the same boat,
that they had exhausted their resources,
and that default and repudiation were
inevitable. On the other, you had analysts
saying that it was impossible to general-ize
about issuers, that most of them had
plenty of resources still available to them,
and that most of them could actively man-age
their way out of the situation.
The final piece of the puzzle appeared at
the very end of the year, although it didn’t
gain traction until later: a white paper by
Joshua D. Rauh of the Kellogg School of
Management at Northwestern University:
“Are State Public Pensions Sustainable?
Why the Federal Government Should
Worry About State Pension Liabilities.’’
Of course, we all know what the answer
to the title’s question was.
This was a provocative piece of work.
Up to this point, as far as I know, nobody
had predicted that pension funds would
run out of cash altogether, or that pen-sion
underfunding might drive states “to
insolvency,’’ as Rauh claimed. Rauh also
introduced his notion that state and local
pension plans should “discount the benefit
cash flows at Treasury rates.’’
In other words, they should stop as-suming
that the assets they had put in
their pension systems would produce 8
percent a year. Discounting benefit flows
at Treasury rates produced a gap between
assets and liabilities of $3 trillion at the
end of 2008, Rauh wrote. He also mod-eled
which states’ plans would run out of
money, and when.
Rauh’s chief assumption was that states
would contribute enough money to their
pension plans “to fully fund newly accrued
or recognized benefits at state-chosen
discount rates (usually 8 percent) but no
more.’’ This was “broadly in keeping with
states’ recent behavior.’’
The paper itself was no easy read, but
the “Table 1: When Might State Pension
Funds Run Dry?’’ was clear enough.
Rauh predicted that Illinois would run out
in 2018, Connecticut, Indiana and New
Jersey in 2019, Hawaii, Louisiana and
Oklahoma in 2020. Alaska, Florida, Ne-vada,
New York and North Carolina would
never run out.
Rauh is now at the Stanford Graduate
School of Business. He didn’t respond to
a request for comment. He has continued
to publish, and his views are now well-known.
It used to be that public pension
funding was one of those things cov-ered
by rating companies perhaps on a
quarterly basis. Now, it seems that we get
regular, detailed updates on their condi-tion
almost weekly. This is a good thing.
People didn’t really start to discuss the
Rauh study until 2010. This would prove to
be the cauldron year for the muni meltdown.
“Are State Public Pensions
Sustainable? Why the Federal
Government Should Worry About
State Pension Liabilities.”
— Title of paper by Joshua Rauh, Kellogg School
of Management at Northwestern University

VII: Public Pensions
The year 2010 was
the peak year for
meltdown mongering.
It was as if with the real estate bubble
burst, banks failing and companies from
auto manufacturers to Wall Street broker-ages
in bankruptcy, gloomsters could
finally turn their attention to states and
municipalities.
Not all the material being published
about public finance was incendiary.
Some was salutary. As the old saying
goes, never waste a crisis. So it was with
public pensions. In February, the Pew
Center on the States published “The
Trillion Dollar Gap: Underfunded State
Retirement Systems and the Roads to
Reform,’’ a thoughtful, comprehensive 61-
page study.
Pew said the difference between what
states had on hand and the pension
and other retirement benefits they had
promised amounted to $1 trillion, and that
was conservative, because it was based
on June, 2008, data and thus hadn’t taken
into account all investment losses.
The Pew report was unhysterical and
exhaustive, filled with maps and tables of
data. It showed the extent of investment
losses, and ranked how the states were
managing the situation. On pensions, it
said, 16 were solid performers, 15 needed
improvement and 19 were “serious con-cerns,’’
while in the area of health care
and other benefits, which most states had
treated as a pay as you go expense, 9
were solid performers in terms of quantify-ing
the obligation and putting aside money
for it. The report also noted that 15 states
in 2009 had passed legislation reforming
some aspect of their pension systems,
usually by making new employees contrib-ute
more.
As if any reminder were needed, the
results showed how the subject of public
pensions resisted generalization. New
York’s pensions were 107 percent funded,
Florida’s 101 percent. Illinois had only 54
percent of the money it needed, Kansas
59 percent, Colorado, 70 percent.
The study also examined investment
return assumptions, just then becoming a
fat target for critics. Recall that in Septem-ber
2009, Pimco’s Bill Gross coined the
term the New Normal to characterize the
low-growth, low-yield future.
The Carolinas calculated they would
earn 7.25 percent, Colorado, Connecticut,
Illinois, Minnesota and New Hampshire
8.50 percent. By far the most states, 22,
were at 8 percent, which, as the report
pointed out, was the median investment
return for pension plans over 20 years.
The report examined the factors that
contributed to the $1 trillion gap, such as
the volatility of investments, states failing
to make their annual actuarially-required
contributions and “ill-considered benefit
increases’’ during good times. It also
examined the “road to reform.’’
Of course the Internet focused on the
“$1 trillion gap,’’ and even more on the
Rauh $3 trillion gap.
A subject that had received scant atten-tion
– except among the rating com-panies,
municipal analysts, some local
newspapers, and the blog that since 2004
collected coverage of the topic, pensiont-sunami.
com – was now in the spotlight.
Public pension analysis was, almost, the
flavor du jour. At least three more aca-demic
reports on public pension liabilities
were published during the year.
‘Distinct Risk to Taxpayers’
In April, the American Enterprise Insti-tute
for Public Policy Research present-ed
resident scholar Andrew Biggs’s “The
Market Value of Public-Sector Pension
Deficits,’’ basically an endorsement of the
Rauh $3 trillion pension gap figure.
Then in June came a working paper by
Eileen Norcross and Andrew Biggs,
published by the Mercatus Center at
George Mason University entitled “The
Crisis in Public Sector Pension Plans:
A Blueprint for Reform in New Jersey.’’
Norcross and Biggs repeated the Rauh $3
trillion gap and advocated defined contri-bution
over defined benefit pension plans.
The latter, they said, presented “a distinct
fiscal risk to taxpayers.’’
And in October, Rauh and Robert
Novy-Marx of the University of Rochester
produced a paper, “The Crisis in Lo-cal
Government Pensions in the United
States’’ for a conference on retirement
and institutional money management
post-financial crisis. The authors looked
at the unfunded pension obligations of
local governments, and concluded that,
if already-promised benefits were dis-counted
at riskless, zero-coupon Treasury
yields, the total unfunded obligation for
the municipalities they studied was $383
billion rather than the $190 billion the
localities themselves calculated.
I was of two minds about the explosion
of interest in public pensions. On the one
hand, I thought it good to focus on the
subject, because it seemed that certain of
our elected representatives over time had
sweetened the salary and public pen-sion
pot in exchange for union peace and
votes, with no consideration for the way
even little enhancements add up. They
also all too often neglected to keep up
with their actuarially-required contributions
to their pension plans.
On the other hand, I objected to the “cri-sis’’
terminology which made it seem to the
uninitiated as if states and localities had
to come up with the money to fill the gaps
overnight. As always, I worried that gener-alizing
about the subject was distracting.
What we really needed was focus: Which
states and municipalities had done the
worst jobs managing public pensions?
More importantly, why? These things
aren’t easy to trace, but glossing over the
subject in favor of big numbers lets the
guilty parties off the hook. What hap-continued
on next page...
Source: Bloomberg/Andrew Harrer
‘The New Normal’: Bill Gross

pened, when, why, and how can we guard
against it happening again?
Amplified Alarm
I think it was around this time, too, that
I became very skeptical of all “studies’’
and “reports.’’ It had taken almost three
decades, and the dawn of the Internet
age, for me to realize that data was not
definitive, that analysts could make the
numbers dance.
I also began growing impatient with
what I came to call the media’s “denomi-nator
problem.’’ Such-and-such costs “$3
BILLION dollars,’’ radio and television an-nouncers
would declare, all but reaching
a full windup to deliver the plosive “BIL-LION.’’
And that was fine. But it matters a
great deal if the “$1 BILLION’’ is part of a
budget, say, of $5 billion, or part of one
amounting to $50 billion or $150 billion.
We emphasize the numerator and ignore,
if we even know, the denominator.
In March, the National Association
of State Retirement Administrators
released two short but meaty reads,
the first on public pension plan invest-ment
return assumptions, the second
an analysis of the Rauh paper. Both
attempted to reassure readers that there
was a basis in fact for investment return
assumptions: Over a 20-year period,
median annualized investment returns
were 8.1 percent; over 25 years, 9.3 per-cent.
In other words, the 8 percent return
assumptions prevalent among public
pensions weren’t fictional.
The analysis of the Rauh paper, “Are
State Public Pensions Sustainable?’’
said that the author ignored incremental
changes being made to improve the long-term
sustainability of public pensions, and
that his central assumption, that states
would make contributions sufficient to
fund newly accrued or recognized ben-efits
but no more, was unsupported by
current practice.
There was, it appeared, another side of
the story. How many Internet commenters
read it, I have no idea. Who cared about
the facts when alarm and exaggeration
could be echoed and amplified?
It had taken almost
three decades, and the
dawn of the Internet
age, for me to realize
that data was not
definitive, that
analysts could make
the numbers dance.
BloomBerg
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BLOOMBERG RANKINGS
Most Underfunded Pension Plans: States
For the fourth year in a row,
Illinois, Kentucky and Con-necticut
top the list of most
underfunded pension plans
METHODOLOGY:
Bloomberg ranked U.S.
states based on their pension
funding ratios in 2013. The
Bloomberg municipal data and
municipal fundamentals teams
collected and supplemented
data from each state’s Com-prehensive
Annual Financial
Report, a set of government
financial statements. Data are
for individual states’ respective
fiscal year-ends as of the date
of publication of the CAFR.
Supplemental pension reports
intended to augment a partic-ular
year’s CAFR were added
to that year’s fundamentals.
Fiscal year-end of supple-mental
pension reports may
differ from the state’s CAFR.
All other reports were carried
forward to the next fiscal year.
The funding ratio provides
an indication of the financial
resources available to meet
current and future pension
obligations. Percentages were
calculated by dividing the ac-tuarial
value of plan assets by
the projected benefit obliga-tion.
Where specific data were
missing in the consolidated
reported totals, the pension
funds were contacted directly.
The District of Columbia
had a funding ratio of 103.6%
in 2013.
Source: Bloomberg
AS OF: October 2, 2014
RANK STATE
FUNDING
RATIO 2013
%
FUNDING
RATIO 2012
%
FUNDING
RATIO 2011
%
FUNDING
RATIO 2010
&
FUNDING
RATIO 2009
%
FUNDING
RATIO 2008
%
MEDIAN
%
1 Illinois 39.3 40.4 43.4 45.4 50.6 54.3 44.4
2 Kentucky 44.2 46.8 50.5 54.3 58.2 63.8 52.4
3 Connecticut 49.1 49.1 55.1 53.4 61.6 61.6 54.3
4 Alaska 54.7 59.2 59.5 60.9 75.7 74.1 60.2
5 Kansas 56.4 59.2 62.2 63.7 58.8 70.8 60.7
6 New Hampshire 56.7 56.2 57.5 58.7 58.5 68.0 58.0
7 Mississippi 57.6 57.9 62.1 64.0 67.3 72.8 63.1
8 Louisiana 58.1 55.9 56.2 55.9 60.0 69.6 57.2
9 Hawaii 60.0 59.2 59.4 61.4 64.6 68.8 60.7
10 Massachusetts 60.8 65.3 71.4 68.7 63.8 80.5 67.0
11 North Dakota 61.0 63.5 68.8 72.1 83.4 87.0 70.5
12 Rhode Island 61.1 62.1 62.3 61.8 64.3 59.7 62.0
13 Michigan 61.3 65.0 71.5 78.8 83.6 88.3 75.2
14 Colorado 61.5 63.2 61.2 66.1 70.0 69.8 64.7
15 West Virginia 63.2 64.2 58.0 56.0 63.7 67.6 63.5
16 Pennsylvania 64.0 65.6 71.7 77.8 85.5 86.9 74.7
17 New Jersey 64.5 67.5 68.1 66.0 71.3 76.0 67.8
18 Indiana 64.8 61.0 64.7 66.5 72.3 69.8 65.7
19 Maryland 65.3 64.2 64.5 63.9 64.9 77.7 64.7
20 South Carolina 65.4 67.9 66.5 68.7 70.1 71.1 68.3
20 Virginia 65.4 69.5 72.0 79.7 83.5 81.8 75.9
22 Alabama 66.2 66.9 70.1 73.9 75.1 79.4 72.0
23 Oklahoma 66.5 64.9 66.7 55.9 57.4 60.7 62.8
24 New Mexico 66.7 63.1 67.0 72.4 76.2 82.8 69.7
25 Vermont 69.2 70.2 72.5 74.6 72.8 87.8 72.7
26 Nevada 69.3 71.0 70.1 70.5 72.4 76.2 70.8
27 Ohio 71.9 65.1 67.8 67.2 66.8 86.0 67.5
28 Montana 73.3 63.9 66.3 70.0 74.3 83.4 71.7
29 Arizona 74.1 74.5 73.2 77.0 79.9 80.8 75.7
30 Arkansas 74.5 71.4 72.5 74.8 77.5 87.2 74.6
31 Minnesota 74.7 75.0 78.4 79.8 77.1 81.4 77.7
32 Utah 76.5 78.3 82.8 85.7 84.1 100.8 83.4
33 Missouri 76.6 78.0 81.9 77.0 79.4 82.9 78.7
34 California 76.9 77.4 78.4 80.7 86.6 87.6 79.5
35 Wyoming 78.7 79.6 83.0 85.9 88.8 79.3 81.3
36 Nebraska 79.2 78.2 81.9 83.8 87.9 92.0 82.8
37 Maine 79.6 79.1 80.2 70.4 72.6 79.7 79.3
38 Texas 80.4 82.0 82.9 83.3 84.1 90.7 83.1
39 Georgia 80.6 82.5 84.7 87.1 91.6 94.6 85.9
40 Iowa 80.7 79.5 79.5 81.0 80.9 88.7 80.8
41 Florida 80.8 81.6 82.3 83.7 84.1 101.7 83.0
42 Idaho 85.5 84.9 90.2 78.6 73.9 93.2 85.2
43 New York 87.3 90.5 94.3 101.5 107.4 105.9 97.9
44 Delaware 88.2 88.3 90.7 92.0 94.4 98.3 91.3
45 Oregon 90.7 82.0 86.9 85.8 80.2 112.2 86.4
46 Tennessee 91.5 91.5 89.9 89.9 95.1 95.1 91.5
47 Washington 95.1 93.7 94.9 92.2 93.9 92.9 93.8
48 North Carolina 95.4 95.3 96.3 96.8 99.3 103.4 96.3
49 South Dakota 99.9 92.6 96.3 96.1 91.7 97.4 96.2
49 Wisconsin 99.9 99.9 99.9 99.8 99.8 99.7 99.9
Median 69.3 68.7 71.6 74.3 75.9 82.3 73.0

VIII: Media Frenzy
It wasn’t long before it
seemed like everyone
was talking about a Muni
Meltdown. The following is a by
no means exhaustive list of some of the
alarming stuff published on munis in 2010.
I’m not including the bloggers who at this
point were advocating defaulting on bonds
on behalf of “the taxpayers’’ or “clickbait’’
compilations like “The 10 Cities That Will
NEVER Come Back’’ that were such a
favorite of Business Insider at the time. I
should note here that Joe Weisenthal,
then of Business Insider, now works for
Bloomberg as Digital Content Officer.
Consider this, from the newspaper of record:
“California, New York and other states are
showing many of the same signs of debt over-load
that recently took Greece to the brink
— budgets that will not balance, accounting
that masks debt, the use of derivatives to plug
holes and armies of retired public workers
who are counting on benefits that are proving
harder and harder to pay.’’
Greek Myths
The story appeared on Page One of the
March 30 New York Times, headlined,
“State Debt Woes Grow Too Big to Cam-ouflage.’’
Reporter Mary Williams Walsh
continued, “Some economists fear the
states have a potentially bigger problem
than their recession-induced budget woes.
If investors become reluctant to buy the
states’ debt, the result could be a credit
squeeze, not entirely different from the
financial markets in Europe, where mar-kets
were reluctant to refinance billions in
Greek debt.’’
Then there was the April blog posting by
Rick Bookstaber, a senior policy adviser
at the SEC. The next big crisis was the
municipal market, he wrote. The culprit:
overleverage, “in the form of high pension
benefits and post-retirement health care.’’
He observed: “Once a few municipalities
default, there is a risk of a widespread
cascade in defaults because the opprobri-um
will be lessened, all the more so if the
defaults are spurred by a taxpayer revolt —
democracy at work.’’
Bookstaber was among those asked by
Brian Chappatta at the end of 2011 about
what happened. His response is contained
in Appendix 2. I chatted with Bookstaber,
who now works for the U.S. Treasury in
the Office of Financial Research, in mid-
November, and he told me he had nothing
to do with the muni market, and declined
further comment.
I knew we had reached an entirely dif-ferent
level of muni crisis coverage when
Matt Taibbi of Rolling Stone, who had
achieved a certain notoriety in 2009 when
he likened Goldman Sachs to “a giant
vampire squid wrapped around the face
of humanity,’’ weighed in with an article
entitled “Looting Main Street’’ in the April
15 edition of the magazine.
The Taibbi piece concerned Jefferson
County, Alabama’s use of interest-rate
swaps, and was subtitled, “How the na-tion’s
biggest banks are ripping off Ameri-can
cities with the same predatory deals
that brought down Greece.’’ The message
was that municipalities were “now reeling
under the weight of similarly elaborate and
ill-advised swaps,’’ which the author termed
a “financial time bomb.’’
It had been quite a few years since I had
read Rolling Stone. I’ve been pretty exer-cised
about municipalities’ use of swaps,
myself. I’m not sure how many Americans
get their investing advice from Rolling
Stone, but they couldn’t have found comfort
in yet another tale of predatory Wall Street
and feckless or corrupt public officials.
The right-leaning Manhattan Institute’s
Nicole Gelinas in the think-tank’s City
Journal advised readers of the Spring 2010
issue to “Beware the Muni-Bond Bubble.’’
Gelinas wrote: “Investors in municipal
bonds don’t have to worry about a thing,
the thinking goes, because the states and
cities that issue them will do anything to
avoid reneging on their obligations — and
even if they fail, surely Washington will step
in and save investors from big losses.’’
She continued: “These are dangerous
assumptions. Just as with mortgages, the
very fact that investors place unlimited faith
in a market could eventually destroy that
market. If investors believe that they take
no risk, they will lend states and cities far
too much — so much that these borrow-ers
won’t be able to repay their obligations
while maintaining a reasonable level of
public services. The investors, then, could
help bankrupt state and local governments
— and take massive losses in the process.’’
Interesting Point of View
This was, I thought, an interesting point
of view. And then: “The uncomfortable truth
is that as municipal debt grows, the risk
mounts that someday it will be politically,
economically, and financially worthwhile for
borrowers to escape it,’’ Gelinas wrote.
Four years on, I asked Gelinas about the
relative resilience of the market. In an e-mail
dated Nov. 16, she replied, “The ‘resi-lency’
is shallow. Pension funds are doing
well because [of] the Fed’s extraordinary
actions to push up asset prices. But
around the nation, from state-level credits
such as Illinois and New Jersey to rich
cities like New York to poorer and smaller
cities and towns all over the place, many
places are still pretty much insolvent,’’
she wrote. “They cannot make good on
the healthcare promises they have made
to current and future retirees, and many
will not be able to make good on their
promises to pensioners. In the meanwhile,
infrastructure deteriorates because money
that should be going to the future is going
to the past. The 2009 recovery act was a
missed opportunity to help states, cities,
and other municipal credits fix their long-term
structural problems, mostly pensions
and health promises, in return for immedi-continued
on next page...
Source: Svein Erik Dahl/John Wiley & Sons
Christopher Whalen

Source: Bloomberg/Ramin Talaie
‘American Repudiation Gene’: James Grant
ate cash; instead, Washington treated it as
a cyclical revenue shortfall.’’
She continued, “That we haven’t seen
bondholder panic is more a sign of the
desperation for yield and the principal-agent
problem (do retail investors really
know the risks that they are taking or do
they see bonds as ‘safe’). It’s harder today
than it was five years ago to assess the
“too-big-to-fail risk” — that is, it is unclear
whether Washington would step in to
save, say, Citigroup bondholders, this time
around, and it is similarly unclear whether
Washington would step in to save, say,
Illinois or New Jersey bondholders or pen-sioners.
In the end, the clearest action that
Congress takes may — or may not — be in
not bailing out Puerto Rican bondholders. ‘‘
Warren Buffett opined on the muni
market at least twice in 2010, telling
shareholders at the Berkshire Hathaway
annual meeting in May, “It would be hard
in the end for the federal government to
turn away a state having extreme financial
difficulty when they’ve gone to General
Motors and other entities and saved them.’’
In June, Buffett appeared before the U.S.
Financial Crisis Inquiry Commission and
predicted a “terrible problem’’ for municipal
bonds “and then the question becomes will
the federal government help.’’
Buffett hasn’t moderated in his views. In
the Feb. 28, 2014 letter to Berkshire shre-holders,
he wrote: “Local and state financial
problems are accelerating, in large part
because public entities promised pensions
they couldn’t afford. Citizens and public
officials typically under-appreciated the
gigantic financial tapeworm that was born
when promises were made that conflicted
with a willingness to fund them.’’
On June 14 of 2010, Ianthe Jeanne
Dugan wrote in the Wall Street Journal
that investors were “ignoring warning signs’’
in the municipal market. The article was
headlined, “Investors Looking Past Red
Flags in Muni Market.’’
James Grant — a friend, for whom
I worked from 1994 to 1999 — offered
another take on repudiation in the June
25 Grant’s Interest Rate Observer, in a
scholarly article headlined, “Concerning
the American Repudiation Gene.’’
“So low are yields, so complacent are
investors, so persistent are fiscal deficits,
so heavy is the weight of post-retirement
employee benefits and so ill-equipped
are mutual funds to deal with anything
resembling a shareholders’ run that we are
prepared to take the analytical leap. On the
length and breadth of the muni market, we
declare ourselves bearish,’’ wrote Grant.
“The repudiation gene is ever present,’’
Grant continued, well into a very scholarly
article. “The question is whether circum-stances
in the tax-exempt market may coax
it out of latency and back into action.’’
I asked Jim about his call this year. On
Nov. 17, he e-mailed: “A swing and a miss.
The muni market has continued to mosey,
there was no run on mutual funds. Perhaps
more to the point, there turned out to be
no homogeneous market on which to be
comprehensively bearish. What’s Paul
Isaac’s line?’’
Grant continued: “As to surprises: Where
we erred was in expecting surprises. The
muni market has not surprised. No drama,
no short-selling, no credit upheaval, no
volatility to speak of.’’ He concluded: “As to
the current Grant’s stance toward munis,
we judge that yields are too low. In that
they resemble yields nearly everywhere.’’
‘A Muni-Bond Bomb’
On Aug. 23, Steve Malanga of the
Manhattan Institute wrote an OpEd piece
in the Wall Street Journal about the SEC
charging the state of New Jersey with fraud
for misleading investors; the article was
entitled, “How States Hide Their Budget
Deficits,’’ and implied that other states may
be guilty of the same thing.
Malanga also had a story in the Sum-mer
2010 edition of City Journal, “How
to Dismantle a Muni-Bond Bomb.’’ He
wrote: “State and local borrowing, once
thought of as a way to finance essential
infrastructure, has mutated into a source of
constant abuse. Like homeowners before
the housing bubble burst, states and cities
have gorged on debt, extended repayment
times, and used devious means to avoid
limits on borrowing — all in order to finance
risky projects and kick fiscal problems
down the road.’’
He offered a handful of reforms, and said
if the state and local debt bomb “can’t be
defused, we’re all at risk.’’
I chatted with Malanga about the lack
of a muni explosion since then in mid-
November of this year. He noted that
rating companies were now putting much
more weight to pension debt in assess-ing
credit, and, “What we’re seeing is a
little more skepticism in the marketplace
because of what happened in Detroit.’’ He
added, “It’s a very uncertain time’’ for the
municipal market.
In September, Meredith Whitney pro-duced
“The Tragedy of the Commons,’’ a
report on the 15 largest states. This would
have gotten a lot splashier coverage when it
appeared had Whitney actually published it.
As it was, she sent out a press release,
but refused to show it to anyone but clients.
I asked for a copy and was told I’d have to
pay for it.
Seeking Refuge
Whitney at the time said she had spent
two years working on the report, which
didn’t predict any state defaults. Yet she
began making the rounds, appearing on
business radio and television and warning
about how overleveraged states were, and
how they needed a federal bailout. In the
Nov. 3, 2010 Wall Street Journal, she wrote
an OpEd piece entitled, “State Bailouts?
They’ve Already Begun.’’
On Oct. 5, the New York Times’s Mary
Williams Walsh wrote about how Harris-continued
from previous page...

burg, Pennsylvania, was seeking to enter
the state’s Act 47 distressed-cities pro-gram,
in a story headlined “Cities in Debt
Turn to States, Adding Strain.’’ She wrote
“Across the country, a growing number of
towns, cities and other local governments
are seeking refuge in similar havens that
many states provide as alternative to fed-eral
bankruptcy court.’’
The Wall Street Journal led its Money
and Investing section on Oct. 10 with
“New Risks Emerge in Munis: Debtholders
Are Left Steamed as Some Cities Forgo
Repayment Promises.’’ The story detailed
Menasha, Wisconsin’s, failure to make
an appropriation to pay debt service on a
failed steam plant.
CALIFORNIA WILL DEFAULT ON ITS
DEBT screamed the Business Insider
headline on a Nov. 16, 2010, story about
bank analyst Chris Whalen’s appearance
on TechTicker. Henry Blodget wrote: “He
says there’s no bailout coming for Califor-nia
— or, for that matter, any of the other
bankrupt states. And that means big losses
for muni-bond holders ...”
On the Brink
Nicole Gelinas offered a prescription for
Congress to aid states, in a Nov. 17 New
York Post piece, “States on the Brink.’’ In
it she quoted Felix Rohatyn, the banker
who helped craft New York City’s res-cue
in 1975, who earlier that month told
Charlie Rose, “We are facing bankruptcy
on the part of practically every state and
local government.’’ Even Gelinas thought
Rohatyn “overstates the case today.’’ She
advised Washington to get ready to bail
out states: municipal market turmoil could
“prove contagious.’’
The Weekly Standard’s cover story on
Nov. 29 was “Give States a Way to Go
Bankrupt,’’ by University of Pennsylvania
law professor David Skeel. He suggested
that both California and Illinois might avail
themselves of such a law.
Skeel didn’t return a call for comment.
His views on Chapter 9 municipal bank-ruptcy
seem not to have changed at all. In
August, he wrote a piece for the Wall Street
Journal, approving Puerto Rico’s new law
allowing certain public corporations to
restructure their debt. “If Puerto Rico can
restructure its debt,’’ he wrote, “there could
be hope for states — particularly Illinois
— whose own finances are sketchy.’’ He
continues to advocate a federal bankruptcy
law covering the states.
The lead story in the Dec. 5 Sunday New
York Times was “Mounting Debts by States
Stoke Fears of Crisis’’ by Mary Williams
Walsh. And on Dec. 7, then-Business
Insider’s Joe Weisenthal wrote about a
Facebook post by Sarah Palin: “Sarah
Palin Knows Where The Next Battle Is, As
She Blasts The Idea of Bailing Out States.’’
Palin wrote: “American taxpayers should
not be expected to bail out wasteful state
governments. Fiscally liberal states spent
years running away from the hard deci-sions
that could have put their finances on
a more solid footing.’’
Now, you might well ask what kind of sto-ries
Bloomberg News was running at this
time. Among the stories filed by the States
& Municipalities team were “Moody’s
Muni Bond Ratings Will Move to Global
Scale,’’ “U.S. States Expect Taxes to Rise
After Facing $84 Billion Gaps,’’ and “Wall
Street Takes $4 Billion From Taxpayers as
Swaps Backfire,’’ this last an investigative
piece quantifying how much in swap termi-nation
fees municipal issuers had paid to
banks since 2008.
And then on Sunday evening, Dec. 19,
“60 Minutes’’ ran a segment entitled “State
Budgets: The Day of Reckoning.’’
“State and local borrowing,
once thought of as a way to finance
essential infrastructure, has mutated into
a source of constant abuse.”
— Steven Malanga, the Manhattan Institute
REAL ESTATE
THIRD QUARTER 2014
CLICK HERE

Before we turn to the events of Sunday,
December 19, a day that will live in mu-nicipal
market infamy, let’s briefly consider
some of the stuff that was published and
subsequently rattled around on the Inter-net,
and the market’s response to it.
The articles that appeared in 2010 were
generally long on headline, short on
specifics.
They shared a common theme: Some-thing
terrible is going to happen. And that
is: States and municipalities are going to
default on their bonds, because they are
all being overwhelmed by debt and pen-sion
obligations.
Most of the stories contained no fine
shading, no nuance, and, unless the
various articles described exceptional in-cidents
that were already well-known and
previously-reported — Harrisburg, Jef-ferson
County, the Menasha, Wisconsin
steam plant, Vallejo’s bankruptcy, various
silly economic development, stadium and
convention center financings — there was
very little that was new. Beyond this rather
large generalization: California, Illinois
and New York, staggering along under
seeming mountains of debt, are all going
to go bust.
Missing Detroit
I suppose if you had wanted to look at
things “nobody was talking about’’ back
then, nobody was talking about Detroit
staggering along toward an eventual
bankrutpcy filing in 2013, or that Puerto
Rico had its own crushing mountains of
debt, or that Jefferson County, Alabama,
would file for bankruptcy in 2011 or that
Stockton, California, would file in 2012.
That would have all been very useful, but
it also would have required a lot of digging
and a ton of luck. Along with predicting
that Michigan Governor Rick Snyder
would specifically authorize Detroit to file
for Chapter 9.
The articles that appeared in 2010
almost all seemed intent on proving “the
market’’ wrong, but only by way of innu-endo.
Most of the authors were confound-ed
by the lack of movement in what they
called “prices,’’ although what they usually
referred to was one or another of various
yield indexes rather than actual trading.
That’s because most bonds only trade
for the first 30 days after being sold. So
when someone writes, for example, “the
municipal market tanked,’’ I want to ask:
How do you know? That’s an equity mind-set.
What really happens is: The bid-side
dried up. It’s not as though you can go
someplace and say, “Okay, I’d like to buy all
the cheap munis now.’’
Finally, some of the provocative material
that was published in 2010 was frankly
political, aimed at public-employee labor
unions, now fingered as the culprits
behind massive state and local pension
liabilities. Their 401(k) accounts and retire-ment
dreams now in shambles, many
Americans were prepared to indulge in
pension-envy.
The municipal bond industry reacted
slowly and thoughtfully to the hysteria. By
the fall of the year, though, the industry
had produced a number of solid, compre-hensible
reports spelling out, basically,
That’s Not How This Market Works.
One of the first responders was Tom
Kozlik, a municipal credit analyst at Jan-ney
Montgomery Scott in Philadelphia.
In the firm’s July 14, 2010, Municipal Bond
Market Monthly, Kozlik wrote, “Many sto-ries
published of late in the popular press
have included overblown perspectives of
municipal market risk.’’
His piece was entitled, “Municipal
Market ‘Myths’ and ‘Truths’ and ‘Veritas
Vos Liberabit’ Which Means, ‘The Truth
Shall Set You Free.’ ’’ He discussed
headline risk, and observed, “Although
recent articles in the popular press try
to portray a balanced opinion about the
status of the municipal market, too often
writers and commentators are not relying
on municipal market experts for facts
about the realities stressing the municipal
market.’’ He continued, “The confusion,
lack of knowledge and resulting fear
mongering we have seen in the print and
televised media has occurred because
Tom Kozlik
IX: The Market Responds to Its Critics
“The confusion, lack of knowledge and
resulting fear mongering we have seen in
the print and televised media has occurred
because of the media’s misunderstanding of
the municipal market.” – Tom Kozlik, municipal credit analyst at Janney Montgomery Scott

of the media’s misunderstanding of the
municipal market.’’
The myths Kozlik addressed: That there
was going to be a “‘Municipal Meltdown’
or a percentage of defaults or municipal
bankruptcies’’ significantly above the his-torical
norm; that the market would crash
like the sub-prime loan market; that there
would somehow be a default or bank-ruptcy
“contagion effect;’’ that California,
Illinois, or New Jersey would be “the next
Greece;’’ that ratings and bond insurance
were worthless.
I’m not sure how many reporters or com-mentators
saw Kozlik’s piece, or the vari-ous
other rejoinders that started to appear
thereafter. Maybe some of this material
got through and was disregarded because
it didn’t fit the narrative, or was dismissed
because the writers felt the analysts in-volved
were somehow discredited.
So much of what I thought passed for
“dialogue’’ in those days was, after all,
privately disseminated. Reporters only
received some of it.
People Unfamiliar
As Kozlik wrote in a retrospective piece
on Aug. 27 of this year, “Several report-ers
were dead set on the idea that the
municipal market was the next sub-prime
market and the municipal market would
melt-down.’’
Most of the stories stoking the hyste-ria
about munis featured quotes by, as
I would characterize them now, people
unfamiliar.
The go-to guy for the insider’s point of
view, someone who actually knew what
he was talking about and wasn’t afraid
of being quoted, was Matt Fabian of the
research firm Municipal Market Advi-sors.
He was the Voice of Reason, the To
Be Sure source in a sea of inexpert tes-timony.
He must have been a very busy
man. In some ways, I performed a similar
role briefly in 1995, after Orange County,
California, went bust. You can look it up.
On Sept. 30, 2010, Fabian produced a
one-sheet “Special Report on Vilifying
State Creditworthiness,’’ a sort-of re-sponse
to Meredith Whitney’s “Tragedy
of the Commons,’’ which he admitted he
had not seen yet. After acknowledging the
report might have some salutary effect in
regard to budget-cutting, pension-building,
debt-deferral and increased disclosure,
Fabian wrote: “We are reluctant to directly
rebut the report without having the docu-ment
itself. However, based on media cov-erage,
it appears to succumb to what has
been a common problem of non-municipal
observers of our market: the conflation of
various state stakeholder exposures.’’
Misunderstood Leverage
States are unlikely to default on their
bonded debt, he said, because of a num-ber
of legal protections. What meltdown
proponents were predicting was a mass,
anarchic, political and legal abdication.
He also addressed “rollover risk,’’ first
broached by Frederick Sheehan the
previous year in his “Dark Vision.’’ Re-member,
wrote Fabian, “that ‘leverage’ is
an often misunderstood term. While states
have greatly increased debt borrowings
over the last five years, essentially all
outstanding municipal debt is self-amor-tizing.
Meaning, similar to a residential
mortgage, principal is paid down regularly
via level annual debt service payments
funded with tax receipts. ‘‘
He continued: “Municipal issuers do not
borrow as do international sovereigns or
the US treasury: via large short maturity
notes that in practice can only be refi-nanced
with more debt, creating a crip-pling
reliance on market acceptance for
solvency. As we saw in 4Q08, an extend-ed
primary market ‘closure’ produced no
knock-on defaults; states simply stopped
funding new infrastructure until rates fell
far enough to justify the cost.’’
John Hallacy, head of municipal
research at the then-new combination,
Bank of America Merrill Lynch, con-fronted
“Apocalypse Muni’’ in a comment
piece on Oct. 1. He acknowledged that
the federal government had already as-sisted
the states: “The ARRA or stimulus
provided several different levels of assis-tance
including extending Unemployment
Insurance benefits. Additional legislation
in the amount of $26 billion was approved
to provide extension of a higher level of
Medicaid reimbursements for two quarters
in the amount of $16 billion, and addition-al
education assistance with the remain-ing
$10 billion.’’
Hallacy also noted, “Debt and the
amount of leverage on the part of the
issuer have never been the best predic-tors
of creditworthiness,’’ and observed:
Source: Bloomberg/Jin Lee
“Tragedy of the Commons”: Meredith Whitney
“Most U.S. states are lightly indebted
compared with regional governments
elsewhere in the world.”
— Gabriel Petek, Standard & Poor’s

“The ratio that matters the most to us
is the debt service carry on the budget.
Most issuers keep this ratio well within 10
percent, and the level is typically closer
to 5 percent. If the debt service carry is
over 10 percent, the reason is most often
because said issuer prefers to amortize its
debt on a more rapid schedule.’’
So maligned had the asset class be-come
by this time that Hallacy added at
the end of his piece, “We are not apolo-gists
for the Municipal Market.’’
Moody’s on Oct. 5 published a Special
Comment, “Why US States Are Better
Credit Risks Than Almost All US Corpo-rates.’’
The Comment described Illinois, at
the time the lowest-rated state at A1, and
then detailed why all of the states, even
Illinois, were of better credit quality than
96 percent of corporate borrowers.
Munis Not Corporates
Fundamental strengths of states, ac-cording
to Moody’s, include the capacity
to increase revenue by taxes; the ability to
cut expenses and capital outlays without
reducing revenue; strong legal protection
for debt service payments; limited conse-quences
to running deficits and accumu-lating
negative balances; less competitive
pressure; lower event risk; and potential
federal support.
This was probably one of the more
important pieces produced during the
crisis, describing as it did the unique char-acteristics
of states (and, by extension,
municipalities) compared to companies.
People unfamiliar have long confused the
equity and municipal markets, in the way
they trade and in the way they respond
to bad news. It is little wonder, then, that
they also likened municipal issuers to
companies. In fact, as Moody’s pointed
out, “Game Over’’ looms over companies
much more closely than it does over
states and municipalities.
On Nov. 8, Gabriel Petek of Standard &
Poor’s published two reports: “U.S. States’
Financial Health and Debt Compare
Favorably With Other Regions’’ and “U.S.
States and Municipalities Face Crises
More of Policy Than Debt.’’
In the first, S&P reminded readers that,
“From a global perspective, most U.S.
states are lightly indebted compared with
regional governments elsewhere in the
world. In our opinion, various constitu-tional
or legal requirements for balanced
budgets — more unusual outside the U.S.
— have kept U.S. states’ debt burdens at
moderate levels.’’
The report compared Ontario, Bavaria,
Basel, Texas, New York, Illinois and
California, and concluded, “in our assess-ment
of U.S. states’ creditworthiness, we
consider debt service payments to be a
very modest proportion of expenditures
and admit that most administrators are
able to manage through severe economic
turbulence, due in part to their relative
lack of leverage. We believe that some
discussions about financial catastrophe
are meaningful only if governments prove
unwilling to use their powers of adjust-ment
to manage their positions.’’
Economic Engines
The analysis included a table of various
financial measures and showed how states
stacked up — pretty favorably, especially in
terms of revenue. California and New York
in particular are economic engines.
The larger piece emphasized state and
local government agency. That is, these
governments have the ability to man-age
their way out of financial crises, and
Standard & Poor’s expected them to do
so: “We believe the crises that many state
and local administrators find themselves
in are policy crises rather than questions
of governments’ continued ability to exist
and function. They’re more about tough
decisions than potential defaults.’’
The report stated that debt service is
usually a payment priority, a legal obliga-tion,
and then considered California,
Illinois, New York and Texas, as well as a
number of localities, including Las Vegas
and Detroit.
From our perspective today, perhaps
Detroit is the most interesting of the
bunch. The rating company was unequivo-cal:
“Michigan has repeatedly indicated
to Standard & Poor’s that it would take all
steps necessary to prevent a[n emer-gency
financial] manager from filing for
bankruptcy protection.’’
Fitch offered a Frequently Asked Ques-tions
written by lead analyst Richard
Raphael called “U.S. State and Local
Government Bond Credit Quality: More
Sparks Than Fire’’ on Nov. 16. I liked it
because it was full of common sense and
treated the subject in straight English, and
reiterated the strengths of the market:
“Due to the 20- to 30-year principal
amortization of debt that is common in
the U.S. municipal market, large bullet
maturities and consequent refinancing
risk is limited,’’ and “Debt service is a rela-tively
small part of most budgets, so not
paying it does not do much to solve fiscal
problems (particularly as compared to the
costs of such an action),’’ for example.
And then the company treated “systemic
risk,’’ or the chance that the entire market
would melt down somehow: “The munici-pal
bond market is diverse, with thou-sands
of issuers, over a dozen distinct
sectors, and multiple security structures.
The legal framework for municipal bonds
depends upon a multitude of constitution-al,
statutory, local ordinance, and con-tractual
provisions. Each municipal bond
sector has unique criteria and risks. Fur-ther,
in many cases, a single municipality
will issue several series of bonds, each
secured by a different type of security.’’
I think the two pieces I enjoyed most
emanated not from the industry but
from the media itself. On Nov. 22, Brett
Source: Bloomberg/Jennifer S. Altman
‘Bold prediction! Don’t back down now!’:
Henry Blodget

Arends of MarketWatch responded to
the Christopher Whalen “California Will
Default’’ interview with Henry Blodget the
previous week.
“Can everyone please stop talking total
nonsense about the California budget?’’
wrote Arends. “I know that facts and truth
seem to be optional these days. I know that
in the exciting new world of infinite media
everyone can choose to believe whatever
fantasies they want. But in the case of
California, it’s getting on my nerves.’’
Arends recounted an e-mail exchange
he had with Whalen, who said “My gen-eral
comments have to do with my guess
as to the impact of mounting foreclosures
and flat to down GDP on state revenues.’’
‘All Henry’s Fault’
Arends replied, “Your guess? These are
important problems, to be sure. But do
you have any actual numbers?’’ To which
Whalen replied, “Revenues fall and man-dates
rise to the sky. You do the math.’’
Arends pressed: “Er, no, actually, it’s your
assertion. You do the math.’’ Whalen finally
blamed Blodget. “I am a bank analyst. I
have not written anything on this. My com-ments
have taken on a life all their own.
This is all Henry’s fault. Call him.’’
“Some prediction,’’ Arends wrote, and
then: “Meanwhile Blodget chimed in on
the e-mail exchange: ‘It’s a bold predic-tion!
Don’t back down now!’ ‘’ Arends
concluded: “Bah. Welcome to the media
world in 2010.’’
He then produced a piece showing that
California, far from being the Greece of
America, was actually the Germany of
America, an economic powerhouse with
a high standard of living, where entrepre-neurs
still wanted to do business and one
of the states that sent far more money to
Washington than Washington redistributed.
It didn’t end there. On Nov. 23, Felix
Salmon wrote about the incident for the
Columbia Journalism Review’s “The Audit’’
blog, which discusses financial journalism:
“In reality, what we’re seeing here is ex-pertise
mission creep, and a rare example
of an expert admitting to it. Whalen’s com-pany
is highly regarded when it comes to
analyzing banks’ balance sheets, and as
a consequence of that regard, Whalen
has gotten for himself a nice perch in the
punditosphere, as well as a new book. But
Whalen, as he admitted to Arends, is no
more an expert on municipal finance than
Freeman Dyson is on global warming. And
so the proper stance for Blodget to take
was not to deferentially pose questions
to Whalen and then passively receive
his oracular words of wisdom, but rather
to push back and have a proper debate
about Whalen’s assertions, as Arends
might have done.’’
This was the clincher for me, though:
“More generally, the municipal bond
market is a very complicated place, where
expertise is hard-earned and voluble
new entrants are inherently mistrusted,
normally for good reasons.’’
Whalen, now a Senior Managing Direc-tor
at Kroll Bond Rating Agency,was one
of those interviewed by Brian Chappatta
at the end of 2011 about the lack (so far)
of a Muni Meltdown, and his comments
lead off Appendix 2. I also e-mailed him
on a recent Sunday to ask him about it.
On Nov. 16, he e-mailed: “The process
has proceeded about as I thought. Cases
like Detroit and Stockton, CA, are the
extreme examples where default has oc-curred,
but in general the political class
has proven able to extend and pretend
with respect to sovereign credits of vary-ing
sizes. Puerto Rico is another case
where the threat of a general default is
being used to forcibly restructure debt. In
the case of GM, which was a sovereign
credit for a time, the fact of default was
used to ride over investors’ rights. Indeed,
GM may well end up back in bankruptcy
because of unresolved pension liabilities
and chronic operational problems. CA was
saved, for now, by Governor Brown, who
is not afraid to say no to both parties in
the CA assembly.’’
Which brings us to “60 Minutes’’ and its
segment “Day of Reckoning.’’
FOLLOW TAYLOR RIGGS ON TWITTER FOR
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“Hundreds of billions.’’
With these three words,
analyst Meredith Whitney
won fame and notoriety
and, eventually, ignominy.
The payoff: Prominent mention in scores
of newspaper, magazine and blog articles,
dozens of appearances on business radio
and television and of course (in February of
2012) the inevitable book contract.
The phrase came almost at the end of a
“60 Minutes’’ episode entitled “State Bud-gets:
The Day of Reckoning,’’ an otherwise
unremarkable and succinct look at public
finance by CBS correspondent Steve
Kroft, which aired on Dec. 19.
Whitney appeared at the end of the
segment, in the role of Expert on the Mu-nicipal
Bond Market. She was, said Kroft,
convinced that some cities and counties
wouldn’t be able to meet their obligations
to bondholders. She said there would be
a “spate’’ of defaults. Asked to define a
spate, she replied, “50 sizeable defaults.
Fifty to 100 sizeable defaults. This will
amount to hundreds of billions of dollars’
worth of defaults.’’
Patted on the Head
Kroft observed that Moody’s and Stan-dard
& Poor’s, “who got everything wrong
in the housing collapse’’ said there was
“no cause for concern.’’ Whitney, who, we
were reminded by Kroft, had spent (with
her staff) “two years and thousands of
man hours trying to analyze the financial
condition of the 15 largest states,’’ wasn’t
buying it: “When individual investors look
to people that are supposed to know
better, they’re patted on the head and
told, ‘It’s not something you need to worry
about.’ It’ll be something to worry about
within the next 12 months.’’
Then Kroft said, “No one is talking about
it now, but the big test will come this
spring. That’s when $160 billion in federal
stimulus money, that has helped state and
local governments limp through the great
recession, will run out. The states are
going to need some more cash and will
almost certainly ask for another bailout.
Only this time there are no guarantees
that Washington will ride to the rescue.’’
Cue the stopwatch.
“Hundreds of billions’’ was the key
takeaway from this segment. Municipali-ties
would default on hundreds of billions
of dollars in bonded debt, and within the
next 12 months, or at least starting within
the next 12 months. Everything else in the
segment, you could say, yeah, every-one
knows that, everyone knows that,
everyone knows that, until you struck the
“hundreds of billions’’ line, and, well, not
everyone knows that.
Bold call! The record year for defaults
until then was 2008, when $8.5 billion
in bonds went into actual or technical
default. And Whitney said — I went back
and listened to the entire broadcast sev-eral
times, just to make sure I had heard
what I thought I’d heard — “hundreds of
billions.’’ As in, not $100 billion, but a mul-tiple,
meaning, at least $200 billion. And
this would be something to be concerned
about within the next 12 months.
Keep in mind when this “60 Minutes’’ epi-sode
aired. It was Sunday, Dec. 19. Most
of the market was either already on the
end-of-the-year holiday or looking forward
to beginning it. Most banks and rating
companies probably weren’t anticipating
putting out municipal market commentar-ies
until January.
There are some columns you can’t wait
to write. This was one of them, for me
(see Appendix I). “Hundreds of billions’’
seemed to me to be in the realm of the
fabulous, and I said so. It made no sense
to me that a boatload of municipali-ties
would all choose to renege on their
bonds, especially since, as Fitch and
others had pointed out just weeks before,
debt service usually makes up a small
part of their costs. Not paying debt service
wouldn’t do much to solve their fiscal prob-lems.
I also included my own prediction for
defaults in 2011: Between 100 and 200,
totaling between $5 billion and $10 billion.
I wrote the column on Monday (the
same day, Whitney appeared on CNBC); it
was edited on Tuesday, and was pub-lished
later that night. It appeared on our
Page One on Wednesday.
Inexpert Witness
By then, both research firm Municipal
Market Advisors and Tom Kozlik of Jan-ney
Capital had responded to “hundreds
of billions,” MMA saying late Monday,
“Given the dire certainty presented by
Whitney, it is a wonder the US equity mar-kets
did not collapse on Monday under
the weight of the anticipated demise of
the state and local government entities.’’
On Tuesday, Kozlik put out a strategy
piece headlined, “There is Not a Loom-ing
Municipal Market Crisis, Although
Many Factors are Stressing Issuers.’’ He
advised: “Investors should not panic and
sell-off municipal holdings.’’
For the next year, and the next, and
even well into 2013, when her book, “Fate
of the States’’ was published, Meredith
Whitney was Topic #1 in the municipal
market. Never had a personality become
such a polarizing obsession. Whitney,
whose remarks were really just a punc-tuation
mark on the “Muni Meltdown’’
hysteria, after all, came to represent all
the inexpert witnesses who had forecast
the market’s imminent demise.
To paraphrase Winston Churchill on
the Battle of El Alamein, before Meredith
Whitney, the asset class never had a win.
After Meredith Whitney, it almost never
suffered a defeat.
The terms of the debate narrowed. Now
instead of a vague “meltdown’’ forecast,
municipal bond defenders, if that is the
right word, could just point to “hundreds of
billions’’ and say, That’s not going to hap-pen,
and explain why.
I think my column was the most-read on
Bloomberg that Wednesday, and I even
got a call from our television producers
to come on and explain myself. This one
column also cast me in a new, heroic role:
Municipal market champion. E-mails of
thanks and praise came in.
This was unfamiliar ground for me. If
anything, I was regarded as a scold by
many bankers, especially for my general
opposition to the use of interest-rate
swaps by all but the most sophisticated
municipal bond issuers.
E-mails ran about four-to-one in my favor,
all of which I duly saved. The pro-Meredith
Whitney ones generally reminded me that
Whitney had called Citigroup dropping its
dividend and how dare I, a mere journalist,
declare myself a better analyst?
X: Oh, Meredith

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