May 18, 2011 / 2:50 PM / 8 years ago

State finances threaten recovery: Whitney

NEW YORK (Reuters) - The dire condition of state and local finances threatens the country’s economic recovery and must be addressed immediately, prominent analyst Meredith Whitney wrote in an op-ed column in The Wall Street Journal on Wednesday.

People fill out paperwork before attending an orientation class at the Manhattan branch of the New York State Department of Labor March 4, 2009. REUTERS/Shannon Stapleton

In a separate interview on Bloomberg radio, she stuck by her prediction that more municipal bond defaults lie ahead, but added a qualification. “I never gave precise estimates or a specific period of time,” she said.

Whitney made her reputation by correctly predicting in 2007 that Citigroup would need a massive capital infusion. Last year, she rocked the $2.9 trillion municipal bond market by her forecast of massive numbers of bond defaults this year.

But with the economy strengthening, there were only nine muni defaults in the first three months of 2011, half the total in the year-ago period. The recent defaults were worth a total of $245 million, down from more than $1 billion at the same point last year, according to data provided to Reuters by Income Securities Advisors in April.

The first-quarter data suggests defaults for all of 2011 would shrink compared with last year’s 84, which totaled $3 billion, said Richard Lehmann, the president of ISA, an investment advisory and research firm based in Florida.

Whitney has been criticized for scaring the market, inspiring individual investors to pull money out of municipal bonds.

“When you talk about defaults in the municipal bond market, the municipal bond market notices right away and gets worried,” said Richard Larkin, director of credit analysis at Herbert J. Sims & Co.

In her op-ed, Whitney echoed warnings that states are underfunding their pension and other post-employment benefits.

“The condition of state finances threatens the economic recovery. States employ over 19 million Americans, or 15 percent of the U.S. work force, and state spending accounts for 12 percent of U.S. gross domestic product.” she wrote. “The process of reining in state finances will be painful for us all.”

Whitney said that while states’ revenues have improved, they are still below pre-recession levels, even as expenses rise.

“The real issue here is the enormous over-leveraging of taxpayer-supported obligations at a time when taxpayers are already paying more and receiving less,” she wrote.

Municipal bonds are securities issued by local governments, U.S. states and territories. A big appeal is that they are often tax-exempt.

Whitney said that taxpayers have had to endure cutbacks and higher taxes while public workers have seen benefit rollbacks.

She said bondholders may be next on the list.

Whitney wrote that defaults “in a variety of forms by states and municipalities are already happening and more are inevitable,” adding that “municipal bondholders will experience their own form of contract renegotiation in the form of debt restructurings at the local level.”

In the Bloomberg interview, Whitney said more credit downgrades of munis will force insurance companies to dump bonds. She said rating agencies will downgrade more and more munis, so that insurance firms will have to sell them since they must hold bonds of a high credit quality.

“You will see forced selling,” Whitney said.

She added that she was worried about the unknown factors in the muni market. “There are restructurings going on now that we know nothing about,” Whitney said.

Additional reporting by Edith Honan; Editing by Dan Grebler

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