Muni bond queen Lebenthal disputes Whitney alarms

NEW YORK Tue Jan 18, 2011 2:05pm EST

NEW YORK (Reuters) - Stick to banks, Meredith, and leave the municipal bond market to the experts. That is what Alexandra Lebenthal thinks.

Lebenthal, whose family name has been synonymous with munis since the 1970s, has had enough of banking analyst Meredith Whitney's predictions of a wave of defaults by states, cities and other public-sector borrowers.

Whitney, among the few analysts who predicted that the housing crisis would hobble undercapitalized banks, has in recent weeks taken to the airwaves to warn viewers of impending defaults in the $3 trillion municipal bond market.

In interviews on business news channel CNBC and a widely watched story called "The Day of Reckoning" on the CBS News TV program, Whitney predicted 50 to 100 municipal issuers representing "hundreds of billions" of dollars of debt could default or restructure their finances.

Lebenthal says Whitney's warnings are overdone.

"I'm very concerned by Meredith Whitney's comments," Lebenthal told Reuters. "Her numbers are way off. She's brilliant when it comes to housing, but I don't think she has the same expertise or credentials when it comes to munis."

Whitney did not return telephone calls to discuss her muni outlook or to respond to Lebenthal's comments. Her firm's reports are available only to clients, the lowest tier of whom pays an annual subscription fee of $100,000.

Lebenthal and her octogenarian father, James, became fixtures of the New York area with decades of television and radio advertising that promoted muni bonds. They sold the family firm in 2001 to MONY Group, but wound up working for Merrill Lynch in 2005 after a series of mergers.

A year later, the Lebenthals left to launch a new firm. They remained champions of munis, though that has been an unpopular position in recent months.

States, cities and other public agencies have been squeezed by a deep recession that sapped tax rolls. Americans see news of Illinois and other states struggling to pay the bills. Harrisburg, the capital city of Pennsylvania, had to be rescued by the state.

Weighing on municipalities is a $1 trillion hole in public pension funds, Whitney said. Municipalities also borrowed aggressively over the years and they overspent: $500 million more than they collected since 2008, Whitney said.

"There's no doubt in my mind you will see a spate of municipal defaults," Whitney told 60 Minutes. "Next to housing, this is the single most important issue in the U.S. and the largest threat to the U.S. economy."

Critics immediately aimed at Whitney, questioning her numbers. The record for muni defaults set in 2008 was about $8 billion.

Whitney has stood behind her views and dismissed the critics. "The people contesting this are the muni bond brokers, who have a lot to lose," she told CNBC.

She told CNBC she is not predicting defaults by states, but rather by towns and other municipal borrowers.

Still many investors seem to share Whitney's concerns.

The exchange traded iShares S&P National Municipal Bond Index fund (MUB.P) is down 5 percent over the past year and down 9 percent in three months, even as the broader stock market rallied.

Investment Company Institute data show that investors withdrew more than $22 billion from muni bond mutual funds since the end of October.

"Retail investors are getting scared and they're doing the wrong thing at the wrong time," she said. "It's a classic reaction by retail investors: they buy high and sell low."

Lebenthal said she heard of one investor who ordered brokers to liquidate his entire $20 million muni portfolio.

On the other hand, famed bond fund manager William Gross of Pacific Investment Management Co invested $5.5 million of his own money in muni bond funds run by PIMCO, Reuters reported on Friday.

Gross this week told CNBC that states will not default. Still, there are signs of distress.

Markit, a firm that monitors credit default swaps. said the cost of insuring municipal debt against default widened by 8 basis points to 227 on Friday. Bond prices have tumbled, with the 30-year triple-A general obligation munis were yielding 5 percent.

Demand in the primary market also lags supply. The New Jersey Economic Development Authority on Thursday, for example, was forced to scale back the week's largest muni bond offering. Vanguard Group also on Thursday canceled plans for a series of muni bond exchange-traded funds.

That said, Lebenthal does not expect a spate of defaults.

For one thing, bond holders have long enjoyed strong protection in the courts, she said, even when New York City teetered in 1975. They come first in line ahead of police, fire, trash collection and other obligations, she said.

The rate of defaults on investment grade muni bonds has been "minimal" going back to the Great Depression because governments can raise taxes and cut spending. Moreover, tax receipts recently have started to revive, she said.

Lebenthal said municipalities face serious challenges, in particular the pension deficit and political wrangling that make it difficult to attack budget problems.

As a last resort, Lebenthal believes the federal government would not allow a state government to default on its debt.

Alexandra & James, the Lebenthal's family wealth advisory business, continues to recommend that its clients buy munis. There are some cities and states which the firm avoids, but Lebenthal continues to recommend double-A and triple-A bonds.

Investors should not sell, she added, regardless of Whitney's warnings.

"I don't dispute her knowledge of the investment banks, but she is not a municipal bond expert," Lebenthal said. "I would put any muni analyst in a room with her -- on TV, outside in the school yard -- and see who comes out ahead."

(Editing by Robert MacMillan)

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