David Kotok, Bond Girl on Michael Lewis' latest Vanity Fair ARTICLE -- a Meredith Whitney critique

rcwhalen's picture

Below is a great post by David Kotok and a related comment from Bond Girl on munis, Michael Lewis and his latest Vanity Fair ARTICLE Whitney critique. The original post is here https://self-evident.org/?p=931  Thanks to David Kotok & Bond Girl for reprint permiso. As I told Joe Mysak at Bloomberg earlier today, I still think that there is a medium term default threat for CA, IL and NY, in that order, but so long as the banks keep paying the advances on foreclosed homes, the problem will be kept at bay.  Meredith Whitney should buy David Kotok lunch and spend some time listening IMHO.  -- Chris

Michael Lewis’ latest piece in Vanity Fair, “California and Bust,” begins with a lengthy defense of Meredith Whitney’s prediction that there would be a wave of defaults in the municipal bond market. I was not planning on writing a response to his article – frankly, defending Whitney’s call at this point is very much like defending Harold Camping’s prophesy on May 22nd, after even the most gullible people have realized that they euthanized their pets for nothing. Who really cares about the intransigent believers that remain, for whom a forceful narrative has always been more relevant than facts?


Whitney’s call for “50 to 100 sizeable defaults” totaling “hundreds of billions of dollars” has not even come close to materializing. According to Richard Lehmann’s Distressed Debt Securities Newsletter, there have been $1.18 billion of municipal defaults through September 22, 2011, compared with $3.61 billion for 2010. In an earlier post, Default and Bankruptcy in the Municipal Bond Market, I suggested that conduit debt for healthcare and housing would continue to be the largest source of municipal defaults this year. In fact, healthcare credits have accounted for 39% of this year’s monetary defaults. The single largest monetary default was a housing project. The Clare at Water Tower in Chicago, a retirement facility that was financed in 2005 with $229 million of bonds, failed to make an installment payment to cure a shortage in its debt service reserve fund, which was a default event that triggered a mandatory tender on $125 million of floating-rate bonds. This meant the trustee had to make a draw on the credit facility that supported the debt. Lehmann has noted that defaults on Florida dirt bonds (which are secured by special assessments on real property) have been the “single biggest [on-going] default event in the history of the municipal market,” with 77% of bonds issued since 2003 having defaulted. (That figure includes bonds that have tapped debt service reserve funds.)


Even more to the point, all but one of these defaults have been on revenue bonds. The only monetary default on the general obligation debt of a municipality this year involved the city of Brighton, Alabama (population 2,945). According to Bloomberg, the city (which is located just outside of Birmingham) lost 19% of its residents from 2000 to 2010. It missed a $22,783 interest and $35,000 principal payment on its $1.2 million of GO warrants. While I am sure this event is tragic for someone, it hardly represents the Armageddon that Whitney predicted.


For much of the first half of the article, Lewis seems to be trying to support Whitney’s argument that states do “a poor job of providing information about their finances to the public,” and that “the scary thing about state treasurers … is that they don’t know the financial situation of their own municipalities.”


Lewis decides to test her assertion, at least as it pertains to California, which is the state Whitney says is in the worst position. Of course, Lewis does not interview Bill Lockyer, who is the state’s treasurer, but Arnold Schwarzenegger, the former governor. His rambling interview with Schwarzenegger, which takes place while the two ride bicycles along the beach, mostly covers the governor’s improbable ascent to political leadership and struggles while in office. Lewis leaves his audience with the impression that the state’s political leadership lacked a nuanced appreciation of the state’s financial management, and that the administration was pretty much winging it. Schwarzenegger likewise confessed to being clueless about local governments in the state: “I’m not into the local stuff … I was born for the world.” Um, okay…


I have the feeling that if Lewis had interviewed Lockyer instead of Schwarzenegger, he would have come away with a very different understanding of state and local finance and a very different view of public officials. But Lewis would not have had to interview anyone to see that Whitney was wrong about the level of financial information that the state government provides its residents and potential investors – he could have just visited Lockyer’s website. On the website, Lewis would have found: a summary of the enacted budget; agency-level detail of the enacted budget; the Legislative Analyst’s Office’s analysis of the enacted budget; the latest monthly General Fund cash receipts and disbursements; a discussion of trends in cash receipts and disbursements; the state’s annual debt affordability report; the latest report on outstanding and authorized state bonds; a searchable database for state and local debt; California state and local government debt issuance data; the California Debt and Investment Advisory Commission’s monthly newsletter; or any of a myriad other publications related to the financial condition of the state and its political subdivisions. Of course, Lewis could also review the state’s financial statements for the last decade at the controller’s website. While state policymakers have spent considerable time debating spending issues, I think it would be difficult to argue that financial trouble catches officials off guard. And while disclosure can and should always be improved, is this not a commendable effort at transparency? How would Lewis’ audience view state officials’ awareness of state and local financial affairs differently if he had mentioned that this information is publicly available and not a mystery as Whitney suggests? (Note: I do not own or work with California bonds.)


What about the monthly seminars the state hosts to educate local government officials on bond math, derivatives, and similar topics? Lewis could have also attended one of the financial management-related conferences the state hosts for issuers, market participants, and the media each year. (They are excellent and informative events.)

TO BCC LIST:   Forwarding this excellent comment about Munis and the Vanity Fair article.  It was written by bondgirl@self-evident.org.    Bondgirl advised in email that she/he desires to remain anonymous.  In our view that is a shame since the piece is so well researched and written and deserves wider readership but will not obtain it as long as the writer weeks to hide behind anonymity.  BTW, we have no way to know if “Bondgirl” is a girl or a boy.    D 

Bondgirl wrote:

“As I was reading Lewis’ defense of Whitney’s arguments, it struck me that he probably did not read Whitney’s Tragedy of the Commons report (as I have). If he had, it probably would have occurred to him that she mostly used data and analysis provided by organizations like the National Association of State Budget Officers (which publishes reports explaining the logistics of states’ individual budget processes and comparing state budget actions) and the Pew Center on the States (to name only a couple). She doesn’t really do any of her own analysis at all – her work reads like an incredibly verbose high school student’s book report. The only remarkable thing about Whitney’s research is that she somehow convinced her clients to pay $100,000 for information that was easily a Google search away (plus a considerable amount of political bloviating). He also would have known that her opinions about local governments were not based on any specific analysis of local credits. She said there would be hundreds of billions of dollars’ worth of defaults in a sector of the municipal market that she had not even studied. And Lewis seriously wishes to defend this kind of reckless and irresponsible behavior?


Lewis makes two other undeveloped arguments in support of Whitney. The first is that her claims have been misrepresented. It seems fairly silly to say that her words have been misrepresented when they have been captured on video and repeated ad nauseam over the past twelve months. And much has been made of how Whitney conflates what she calls “defaults on social contracts” and what most rational people would consider a default, which is a failure to observe terms of the bond contract or a failure to make timely principal and interest payments. (That is not misrepresenting her views, but providing a legitimate criticism of her sense of what constitutes a credit event.) In interviews, Whitney has generally moved back and forth between the two as is convenient.


But “she was referring to the complacency of the rating agencies and investment advisers who say there is nothing to worry about,” Lewis offers. As I have already explained, until recently, the rating agencies inexplicably rated munis on a tougher scale than other kinds of credits, and most of the monetary defaults the market sees are on bonds that had junk ratings or were unrated when issued. Lewis would know this if he had actually researched credit events in the marketplace before writing his article.


Lewis’ other defense is that:

Whatever else she had done, Meredith Whitney had found the pressure point in American finance: the fear that American cities would not pay back the money they had borrowed. The market for municipal bonds, unlike the market for US government bonds, spooked easily. American cities and states were susceptible to the same cycle of doom that had forced Greece to seek help from the International Monetary Fund. All it took to create doubt and raise borrowing costs for states and cities was for a woman with no standing in the municipal-bond market to utter a few sentences on television.


Ah, yes, the inevitable analogy to Greece. I have explained in prior posts why this analogy makes no sense, and how state and local governments are not dependent on short-term market access in the same way the US government and European sovereigns are. When municipal rates increased, state and local governments simply stopped issuing bonds. The fact that they could do so and not have immediate, bailout-inducing debt crises communicates volumes about the financial strength of the credits in this market. Also, the highest the benchmark Bond Buyer 20-Bond GO index reached following Whitney’s 60 Minutes interview was 5.41% on January 20. What conclusions would Lewis’ audience have drawn from his article if he had compared that to yields on Greek bonds? I would also submit to you that the market will be less vulnerable to such hysteria going forward precisely because Whitney has been so embarrassingly incorrect. Trusting Whitney was an expensive lesson for dumb money. (It was a terrific opportunity for private wealth and more savvy investors, however.)


The truth is that Whitney’s 60 Minutes interview coincided with the expiration of the Build America Bond program, which had caused a glut of new issuance in the market and was already driving rates up. Major structural shifts were already underway in the market, and the BAB program had been the last support. Either accidentally or deliberately, Whitney made her call in the middle of a perfect storm for munis. And she was still wrong.


I do not have much to say about the remainder of Lewis’ piece except to express a general frustration with the way journalists seem to equate anecdotal evidence with genuine financial analysis in terms of credibility. Yes, Vallejo’s situation is a prime example of how political paralysis can morph into a vicious economic feedback loop and legal industry stimulus program. But presenting Vallejo as indicative of a trend is another matter. Did other governments make generous commitments during periods of economic prosperity? Sure, it is almost impossible for political officials not to do this kind of thing. But are other governments pushing themselves to the brink by not addressing this issue? Lewis’ audience wouldn’t know, because he did not interview the mayors of any of the two-thirds of the 296 California municipalities (as surveyed by the League of California Cities) that are in the process of renegotiating changes to their retiree benefits plans. I suspect if Lewis had, he would have discovered that other cities have internalized Vallejo’s situation.


I hope no one will read this and think that I believe the municipal bond market is without risks. This is not true. (The most likely source of a major disruption in the municipal bond market in the near future is the tax status of the bonds – not massive defaults – in my opinion. But that is a topic for another post.) The municipal bond market is a complicated market. Many investors I have spoken with fail to appreciate the differences between claims, that there are different sectors in the market, the difference between conduit and government bonds, etc. This is a market where the difference between issuers matters. People like Lewis and Whitney, who are trying to sell a canary-in-the-coal-mine version of the market, are doing investors a disservice. There are hundreds of municipal bond market professionals that understand these matters on a granular level, have more than a couple years’ acquaintance with the market, and have actually analyzed local government debt, but you are unlikely to read about them in Vanity Fair or see them interviewed on 60 Minutes offering a counterpoint to Whitney. Why is that?


As a postscript, someone should ask Whitney why she has not formally submitted an application to the Securities and Exchange Commission for NRSRO status. (Remember how she was going to create a rating agency?) The SEC would have to waive its requirement that ten large institutional investors pledge they have relied on Whitney’s credit analysis for three years. Is she having trouble convincing the SEC to do so, or was she not sincere about establishing a rating agency in the first place? Inquiring minds want to know.”

Thank you, Bondgirl for permission to share this missive.

David R Kotok

Chairman & Chief Investment Officer

Cumberland Advisors

One Sarasota Tower | 2 N. Tamiami Trail | Suite 303 | Sarasota, FL 34236

614 E. Landis Avenue | PO Box 663 | Vineland, NJ 08362-0663

(800.257.7013 x 320  | NJ fax: 856.794.9113 | FL fax: 941.554.4352

* david.kotok@cumber.com |Website: www.cumber.com

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Quinvarius's picture

The Whitney haters declare victory after a few short months.  Which means the muni implosion, which is  a mathematical certainty without an intervention, is just around the corner.

??'s picture

Meredith Whitney should buy David Kotok lunch and spend some time listening IMHO.  -- Chris

Chris did you ever read the transcript or see the interview with Whitney?   instead of  offering up the musings of  a blowhard who is  in the order of Biggs and Birinyi  and who has an agenda - why not post the transcript of Whitney's interview and actually take the time and put in some  effort to respond to it yourself.



Eally Ucked's picture

What kind of shit is this? Debt is debt and everybody knows that starting from Federal level to every single citizen (sorry 1% or maybe 10% of them excluded) are in debt to the hilt.
Nobody cares if it’s “conduit debt for healthcare and housing”, “Florida dirt bonds” (?) and also they don’t care that “all but one of these defaults have been on revenue bonds”. “General obligation debt of a municipality” is ok? Will see how long they will be in that state when they drive residents out with increases of taxes and disappearing jobs.
“The municipal bond market is a complicated market. Many investors I have spoken with fail to appreciate the differences between claims, that there are different sectors in the market, the difference between conduit and government bonds, etc” who cares, you’ll risk your money because there is some obscure difference between sectors, especially if you don't understand them?
“There are hundreds of municipal bond market professionals that understand these matters on a granular level” I’m happy to hear that we have them still around! Hope they will disappear fast with their granularity or whatever it is.

masterinchancery's picture

In general, this article is utter crap with respect to most of the large, generally liberal States.  They got a temporary reprieve from the "stimulus" handouts, but they are far under water and driving business away steadily with their tax increases.  ANd as MW speculated, the more prudent states are not going to want a bailout of their big spending neighbors.

By the way, Illinois defaulted on its obligations twice in the nineteenth century, so statements about how States never default are simply wrong.

??'s picture

Whitney’s call for “50 to 100 sizeable defaults” totaling “hundreds of billions of dollars” has not even come close to materializing.


when pray tell did she provide a timetable?


from a month ago (which begs the question why regurgitate his crap here?

KOTOK: Stocks Are Cheap, Economy Will Recover, Bernanke Did Right Thing


falak pema's picture

ever heard of debt monetization? Print, print, print n kick the can. A world wide depression in 2012 will accelerate the MW scenario...the printing will feed the hyperinflation cycle.

PulauHantu29's picture

States are on borrowed time just like most banks from what I can see based on facts...not the VooDoo BS flowing out of MSM and DC.

In fact, they keep spending & digging deeper into deficits expecting the Feds will Bail them out.


oldman's picture

'Money good' munis are having their problems, but how else will the most important essential services for places where people WANT to live be financed? And if a new way of doing business does come along---the outstanding debt will have to be retired.

Oh yeah, we could see the end of civilization and lose our money, but it will still be there after we have lost many other more important things. State banks are a good idea when there is integrity and honor----maybe these standards will return, but that also means paying the old debt that was voted upon and viewed as essential for life in a given community.

Munis are probably the last place where common-sense prevails and fundamentals are critical----

I have always been comfortable with munis----the right bonds, the right indenture, and the right community still have meaning.



I am a Man I am Forty's picture

Michael Lewis is my favorite author, but his article in VF was garbage.  His rant on MW was not thoughtful and made little sense.  It is the only thing that ML has written that I did not finish.

As I have stated on this blog numerous times, Meredith Whitney does not know what the fuck she is talking about when it comes to municipal bonds.  Period, the fucking end.

BTW, I own a ton of municipal bonds (none in CA, NJ, or IL) that were purchased mostly prior to 2007 and absolutely hate it when one matures.  I do not buy municipal bonds now because they don't pay shit.


masterinchancery's picture

So apparently you do accept her analysis in part, since you won't buy the most bankrupt states.  As a long time resident, bond holder, and analyst of Illinois finances, it is beyond obvious that, without a vast infusion of federal money, or maybe money from the Andromeda galaxy, Illinois will eventually default on both bonds and pensions; the math is inexorable.  Did you read the part about San Jose being eaten alive by municipal pensions?   Same thing in Illinois, although Obama slowed the process slightly by handing billions to Illinois pols and unions from the "stimulus".     So please tell us, what is the Truth about munis--what force will save  California, Illinois, NY, NJ, etc?

jm's picture

I don't think anybody dissagrees about these issues.  But these issues were well known before Meredith Whitney even started talking about munis.

apberusdisvet's picture

so what happens when property owners say no to the latest tax increase to support unsustainable public sector pensions?  Either they lose their property (homes) or there is blood in the streets.  Whitney was just a few years too soon in her analysis.

The next local budget hearings should be interesting; the sheeple are fed up.

ZackAttack's picture

I'm still sorta lost on how the sub-sovereigns (the states) can have an equal or higher credit rating than the sovereign (the US after the downgrade).

SwingForce's picture

I have a Dream, that someday ALL Florida Condo Associations will have a website with the transparancy that the State of California provides. Ah, until that day, however, these FL "Non-Profit" entities have the unbridled power to assess their captive citizens and spend on themselves. It all starts here folks, and works its way straight up to Washington DC. There are $Billions wasted each year on property managers and accountants, lawyers too. Somebody should write a book... awe, who cares.

goodrich4bk's picture

Did Mr. Kotok or anybody at Cumberland Advisors forsee the fall of Bear, Lehman or AIG?  Did they anticipate the historic collapse of bond yields in the past couple of years?  Did they get any of their clients into gold when it was less than $300 an ounce --- or even when it was less than $1,000 an ounce? 

As for Bond Girl, I'd love to judge her past investment advice but she has chosen to remain anonymous.  At least Whitney has the courage of her convictions.


Deadpool's picture

Lewis does what he always does here: interview interesting people on the scene and insert their witty comments into a narrative that is way bigger than he can possibly understand from the "man on the street" like the lady car driver or hot dog stand vendor he quotes in his other pieces on Greece, Iceland, etc. Infotainment.

JOYFUL's picture

nice slam on Meredith.

you are unlikely to read about them in Vanity Fair or see them interviewed on 60 Minutes offering a counterpoint to Whitney. Why is that?

Probably cause she has made some major correct calls, that just like the one under discussion here, went pretty unheeded until they turned out to be just that...sadly, both Kotok and his shadowly army of "municipal bond market professionals that understand these matters on a granular level" don't appear to have been able to duplicate let allow best that performance, and therefore have not received the desired calls from major media producers....or receive subscriptions from major money players who prefer not to be left out in the cold second time around.

Florida and NJ huh? I assume the Jersey location is for the purpose of accessing the vineyards needed for all the sour grapes you stomp...

no2foreclosures's picture

"There are hundreds of municipal bond market professionals that understand these matters on a granular level . . ."

Mr. Kotok and Ms. Bondgirl better take their heads out of theirs asses and look at the macro level.  These munibonds will collapse as soon as the US "treasuries" go the way of the dodo birds, sooner when the housing market collapses another 20-40%.

Panafrican Funktron Robot's picture

I actually don't see defaults happening either (at least in the "maturity less than 10 years" class), even in the likely suspects.  There's too many biddable public assets.  The Dem profligates generally sell off those assets, whereas the Repub profligates simply take the hammer to public spending, typically in regulatory or "soft" (non-police/basic infrastructure) spending.  

Lazane's picture

I am familiar with a city of 10,000 in middle america who over the course of the past decade saddled itself with 62 million in long term debt that today risks the potential of a municipal bond default more so now than at anytime in its history. the potential cascading effect of reduced taxreceipt cash flows federal state and local have never been more apparent and likely to continue since the 1930's. all it will take is one hiccup in the cash flow gravy grain and the cars jump the tracks, oh!  the misery that could come from it all. 

hannah's picture

the muni market will collapse when washington dc stops pushing bailouts to it......the idiots that wrote this article act like the states didnt recieve any bailout money? whtney was correct...the muni's did 'collapse' but the fed gov came in and backstopped them so they didnt collapse....oh and the feds did it with QE money....and that can continue how long.....?

MrPalladium's picture

"whtney was correct...the muni's did 'collapse' but the fed gov came in and backstopped them so they didnt collapse"