Right about now, she’s probably hoping you forgot. Whitney is the analyst who said,

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

She went on to say that there could be 50 to 100 sizable defaults or more and that those defaults would amount to hundreds billions of dollars worth of defaults.

Municipal bond markets reacted by bidding up the yield for muni bonds.

Most experts didn’t buy Whitney’s prediction. Even I wrote a 2011 article about how safe are muni bonds when people kept asking me about it. Of course, none of those stories was a big, inflammatory prediction of doom from a “name-brand” financial analyst.

Analyst Predicts Muni Bond Defaults

Wall Street and the financial markets are a very weird place. Preeminent analysts are created by making market calls or predictions that come to pass, especially when they make calls that no one else saw coming. Ironically, those same analysts aren’t necessarily held accountable when they make bad calls.

Goldman Sachs’ Abbey Joseph Cohen made a name for herself by making ever higher market calls during the technology fueled stock market bubble of the late nineties. When other analysts concluded that there was no rational basis for the stock market to go any higher and predicted a downturn, Cohen was always there with an even higher market prediction, and she was right (for a while).

Unfortunately for the people that listened to Cohen, she was most decidedly not right about when the market would finally turn. Indeed, when the market first began heading down, Cohen predicted a rebound. Listening to her would have cost you much more money that it would have made. In fact, Cohen predicted an UP year for the stock market in EVERY SINGLE YEAR during and after the internet bubble popped, which means she has NEVER thought the stock market would go down.

It’s a sad fact that there is little or no real accountability in the investing world. The bond rating agencies Moody’s, Standard and Poors and Fitch have suffered no negative effects from rating toxic mortgage securities as AAA until long after it was obvious to EVERYONE that there were problems. Many securities went straight from AAA to Junk status, an admission that the AAA rating was either gross incompetence or outright fraud. Either way, all three companies continue to prosper.

Meredith Whitney’s Muni Bond Default Prediction Defaults

Financial analyst Meredith Whitney rose to fame by making a call warning about bank stocks in 2007, before everyone else realized the ship was sinking. Later, she predicted the dividend cut by Citigroup, further cementing her reputation as someone who saw things others could not see.

In mid-December of 2010, Whitney made another call no one was making, that muni bonds were headed for big waves of failures. The reality is that despite a very tough 2011, the end of stimulus dollars flowing from Washington and state and local tax collections below predictions, there have actually been FEWER muni bond defaults in 2011 than in previous years.

The closest thing to Whitney’s prediction were two defaults late in the year when Harrisburg, Pennsylvania and Jefferson County, Alabama defaulted. That $3 billion is a far cry from the hundreds of billions Whitney predicted. A closer looks shows a flawed project and not a tidal wave of financial problems sweeping up an entire county’s finances. Remember, the giant (and very real) financial issues of California led to not one single dollar of California muni bond defaults.

In the real world, Whitney’s credibility should be destroyed. In the world of finance, however, Whitney will lie low for a while before putting a better spin on her remarks. There will be caveats, and things that she said elsewhere in much lower profile that seem to make her bold prediction less of a failure.

The terminally stupid will by into this spin, and use it to defend her. But, the fact remains that when the press was swirling around and her name was in big BOLD headlines, she did not make one remark, give one interview, or say one single thing that suggested she was in any way uncomfortable with how her prediction was being represented. Only now, after she has been proven wrong and it looks bad for her will she suddenly point out the subtle nuances that meant it was all just a big misunderstanding.

For 2012, make your investing resolution to be, “To stop listening to analysts who make their living by making a lot of noise with big predictions.” After all, sooner or later you’ll be listening to Abbey Joseph Cohen call an up year for the markets in 2008, or Meredith Whitney telling you to get out of bonds before all those non-existent defaults in 2011.

Related posts:

1. Muni Taxes Stay the Same
2. PIMCO Total Return Bond Fund Cuts U.S. Government Holdings

Meredith Whitney Muni Bond Defaults Fails to Materialize originally published at Finance Gourmet

Recently, the mutual fund reported its holdings. Like all mutual fund reporting, the data provides only a snapshot of one day of holdings within the fund. The Wall Street Journal reports that the allocation of assets in the Total Return fund in U.S. Government bonds and securities dropped again to just 12 percent of the overall portfolio, down from 22 percent at the end of 2010.

Gross has become increasingly critical of the government’s intervention in the bond market and in particular of the Fed’s action to hold down interest rates by buying U.S. treasuries.  One can understand his frustration as these manipulations make it difficult for a money manager to do his job, regardless of their overall value (or lack thereof) to economic stability and growth.

The real irony is that with U.S. treasury yields depressed, and Gross having sold out almost anything he can at the Fed’s inflated pricing, there are few places to turn for higher yields.  The amount of the Total Return mutual fund allocated to the mortgage sector now stands at 42 percent.

If you want to follow this bond oracle down the investment trail, you’ll have to not only dump a large hunk of government bonds, you’ll need to step in and buy some more mortgage bonds.

Have a profitable Tuesday.

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1. Meredith Whitney Muni Bond Defaults Fails to Materialize
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PIMCO Total Return Bond Fund Cuts U.S. Government Holdings originally published at Finance Gourmet

Bonds issued by the US Government are low-risk investments issued in order to finance the national debt. There are numerous types of Government bonds. Each bond has specific features that determine how much interest is paid to the bond holder, how long the bond’s term is, and how the bond is purchased. The different kinds of bonds are known by their "series" letters. Series E bonds are one of the kinds of US Savings Bonds.

The last of the Series E Savings Bonds stops earning interest in 2010, which means that anyone still holding Series E Bonds is losing out on interest payments soon. Smart financial planning tips from many experts suggest re-evaluating Savings Bond advantages and disadvantages before automatically rolling them over into new Savings Bonds like the current Series EE Savings Bonds.

History of Series E Savings Bonds

Series E bonds, or Government E Bonds, were first issued to fund World War II efforts. The bonds were commonly known as war bonds. The very first E bond was purchased by President Franklin Delano Roosevelt. The term E bond was just an extension of the original savings bond naming system. Earlier bonds were called "baby bonds" and were named as Series A, B, C, and D bonds. Thus the question What does Series E bond mean can be answered best by saying that it only means that E comes after D.

Early versions of US Savings Bonds were sold through the Post Office. People often still ask about buying Government Bonds at the Post Office as a result of either remembering the earlier practice, or having heard about it from older relatives like parents or grandparents who used to buy bonds in that way. Today, US Savings Bonds are sold by some banks, although the majority are sold through the U.S. Treasury Direct Website for selling savings bonds.

Quick interruption for the writing business start-up guide.

In 1941 when the Series E bond was created, a national volunteer program was created. The country’s business leaders and financial institutions helped sell the war bonds. The sale of Series E bonds allowed the country to quickly increase production of goods needed to fight World War II and continue funding the war effort in general. This patriotic slant toward the sale of bonds greatly increased the number of households with bond investments and raised awareness of U.S. Government Savings Bonds.

Savings Bonds became a staple of most personal financial planning advice because of their safety and low minimum investment.

Characteristics of Series E Savings Bonds

>E Bonds were issued for a fixed-term. The bonds matured after 10 years, but could be granted extensions that allowed them to earn interest for up to 30 or 40 years, depending upon issue date. E Bonds that were issued between 1941 and November of 1965 earned interest for 40 years. The other E bonds issued between December 1965 and June 1980 earned interest for 30 years.

Series E bonds were first sold in 1941 and continued to be issued until they were replaced by Series EE bonds in 1990. That means that the last Series E bonds stop earning interest in 2010. Series E bonds issued before September 1979 have already stopped earning interest.

E Bonds were originally sold for 75% of their face value and they earned 2.9% interest. Original denominations were $25, $50, $100, $500, and $1,000. Later, a $5,000 and $10,000 bond were added, and soldiers were offered a $10 denomination.

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US Savings Bonds Series E Savings Bonds originally published at Finance Gourmet

Note that we are talking about BONDS here, NOT Notes, which are a whole different deal.  Unless you are an expert or near-expert bond trader, you should stay away from any and all notes of any kind except those from the US Treasury.

But, that can’t be the end of it.  After all, there are some examples of muni bonds going sour, most notably Orange County’s default on some of its muni bond debt. 

And, of course, various municipal bonds which were pegged to specific projects or revenue streams have gone belly up.  Of course, it is pretty easy to spot which ones have that kind of risk.  Bonds fully backed by the state, county, or city are generally as safe as you can get without investing in a US Treasury.  Also pretty safe are bonds back by utilities (water and sewer especially) since people have to pay for those one way or another. 

The ones you have to watch out for are the ones that are for building a specific project and then funded with the revenues from that project.  Common examples are things like an aquarium, stadium, road, business park, mall, and so on. Those can and do default pretty regularly, so you’ll really want to make sure you know all about the project and all about municipal bonds before you dip a toe in there.

When it comes to regular municipal bonds though, they tend to be as safe as anything can be without being backed by a federal agency like the FDIC or NCUA.

Here is an example.  Today’s CNNMoney site (among others) reports that California is delaying $3.5 billion in payments.  The list includes taxpayer refunds, contractors, counties that get money from the state, and even social service agencies.  Do you notice what is missing from that list? 

Nowhere in any news story in any paper or on any website do you see even a hint that California is considering for one second not making timely interest payments on California Muni Bonds.  In fact, while Fitch was downgrading California Revenue Anticipation Notes, or RANs, (what did I tell you in the second sentence?) it made no moves to lower its A+ rating (with negative watch, from before this news) for California municipal bonds.  That is a pretty good example of how safe most municipal bonds are.

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1. US Savings Bonds Series E Savings Bonds
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How Safe Are Municipal Bonds originally published at Finance Gourmet

Taxes and Bonds

Because interest on bonds is taxed as ordinary income, avoiding taxes on that interest is more important to investors than avoiding taxes on dividends paid by stocks. Most corporate bonds are taxed at both the federal and state level which reduces the real rate of return to the investor. Municipal bonds issued by states are exempt from federal income tax because one branch of the government cannot tax another branch. Whether or not the state municipal bonds are exempt from state income tax is determined by the laws of the states they are issued in. Most states make their own bonds tax-free as a way to make them more attractive for purchase. This [tag]tax-free[/tag] status, plus the relative safety of most municipal bonds can make them an attractive investment for those in higher tax brackets.

However, these same benefits mean that muni bonds generally pay lower rates than other bonds. For federal taxes, if you are in a low tax bracket, the lower rate can actually mean a lessor overall return than if you invested in corporate bonds. The break even point is often somewhere around the 25% tax-bracket or above.

For state taxes, the analysis depends on the state you reside in. In Colorado, state income taxes are a flat 4.63% while in California, they go up with income like federal taxes. So, an investor in Colorado below the 25% income tax bracket may not reap any benefit from the tax-free nature of municipal bonds, while an investor in a higher bracket in California may come out way ahead by investing in California municipal bonds.

Higher Yield Muni Bonds

Some states do not have an [tag]income tax[/tag]. (They usually have much higher sales taxes or property taxes than those that do.) For those states, municipal bonds can carry a higher interest rate. Texas, for example, does not have an income tax. Therefore, there is no advantage to Texans to buy Texas issued municipal bonds over those issued by other states. As a result, similarly rated Texas Municipal Bonds often end up paying a higher interest rate in order to attract investors. If you are looking to invest in municipal bonds but don’t need the state income tax deduction for your planning purposes (if you live in a low income tax state) then when [tag]investing[/tag] always make sure to check out the non-tax state’s municipal bonds as well as your home state.

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1. Meredith Whitney Muni Bond Defaults Fails to Materialize
2. Not Cashing Savings Bonds to Avoid Taxes

Muni Taxes Stay the Same originally published at Finance Gourmet