April 20, 2014

Charlie Gasparino wonders if Whitney’s call on cities’ debt problems was a favor for clients

Well-heeled investors banking on public bankruptcies?

I still can’t believe Charlie Gasparino went to the Fox Business Network – which is a piece of steaming dung compared to CNBC – but he’s good and I look in on his continued work from time to time. Lately he’s been tweeting and talking about a call financial analyst Meredith Whitney made late last year predicting hundreds of billions of dollars in municipal bond defaults this year. She also participated in a CBS 60 Minutes piece and restated her negative outlook:

Whitney believes the states will find a way to honor their debts, but she’s afraid some local governments which depend on their state for a third of their revenues will get squeezed as the states are forced to tighten their belts. She’s convinced that some cities and counties will be unable to meet their obligations to municipal bond holders who financed their debt. Earlier this year, the state of Pennsylvania had to rescue the city of Harrisburg, its capital, from defaulting on hundreds of millions of dollars in debt for an incinerator project.

“There’s not a doubt in my mind that you will see a spate of municipal bond defaults,” Whitney predicted.

Asked how many is a “spate,” Whitney said, “You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars’ worth of defaults.” (Source)

Gasparino, a well-known and respected Wall Street reporter and author of one of the best books I’ve read on the back story of the financial crisis, interviewed Lawrence McDonald today, a former Lehman bond trader and author of A Colossal Failure of Common Sense. McDonald’s specialty is the bond market. He and Gasparino seem sceptical of Whitney’s position.

The New York Times tonight has a story about a nascent movement to push for the creation of a legal way for states to declare bankruptcy, much in the same way municipalities may now do through Chapter 9. The Times reports that in the past two months $25 billion has flowed out of mutual funds which invest in muni bonds. Gasparino and McDonald discuss these funds outflows and Gasparino points out that many well-heeled investors made a killing off of credit default swaps on state and municipal debt in the wake of Whitney’s call and 60 Minutes story.

The big question I have is public debt going to take the place of mortgage backed securities as the high risk, high reward play of the near future? If that happens, how long until the party gets out of hand and there are consequences? Finally, how far down the economic food chain will the damage go – and will taxpayers be on the hook for the poor behavior and gambling of others?

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