Failing local municipalities could lead to another financial crisis

U.S. bonds.


STACEY VANEK SMITH: A new report finds cities in pretty serious trouble. Financial analyst Meredith Whitney says we're about to see another economic crisis because of local economies failing. She made her reputation by seeing trouble with big investment banks before they collapsed in 2008. Is she right this time around?

Here to talk about this with us is our own Eve Troeh. She joins us live here in our LA studio. Good morning, Eve!

EVE TROEH: Good morning.

VANEK SMITH: Eve -- tell us, what did Whitney say?

TROEH: Well she said that cities, counties and towns failing next year, the way that big banks failed a couple of years ago. She says local governments have seen a huge drop in tax revenue, largely due to unemployment. Dozens of municipalities are already failing to pay their pensions, or even pay their employees on time. And that's going to reach a head next year. She says we'll see 50 to 100 local governments fail to make good on hundreds of billions of dollars in bonds. Here's how she characterized that impending crisis on "60 Minutes" recently.

MEREDITH WHITNEY: It has tentacles as wide as anything I've seen. I think next to housing this is the single most important issue in the United States, and certainly the largest threat to the U.S. economy.

VANEK SMITH: From what I understand though, there's some serious backlash against her predictions. Why is that?

TROEH: Well no one really doubts that local governments are in trouble. But is it as dire as Whitney says. She has a 600 page report on the topic, but it's only for her clients. So analysts want to see her specific numbers. Bloomberg commentator Joe Mysak calls her prediction "in the realm of the fabulous," which is pretty harsh. He says the record for municipal bond defaults is about $8 billion in a year. That was in 2008, when the financial crisis hit. And obviously to get to hundreds of billions from $8 billion, that would be staggering.

VANEK SMITH: The realm of the fabulous -- Eve Troeh, thank you!

TROEH: Thank you.

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Surprised you didn't mention that Warren Buffet, his Oracle-ness himself, saw the bond crisis coming back in June. (Bloomberg 6.4.10: "Warren Buffett, whose Berkshire Hathaway Inc. has been trimming its investment in
municipal debt, predicted a 'terrible problem'for the bonds in coming years.")
Not surprised that the gent you quoted saying the only solution is cutting spending and raising taxes--predictably but foolishly overlooked what many call the only palatable solution: public-private partnerships (PPPs). US banks and equity funds are sitting on billions of dollars of private capital and keen to invest in stable, long-term assets, e.g. infrastructure; PPPs drive overseas economies and have done so for decades. The proposed National Infrastructure Bank includes PPPs (with insufficient emphasis) as part of the solution. Unleash the power of America's greatest asset, the private sector, and the bond problem is mitigated, infrastructure is rebuilt, millions of jobs are created and the country can gets back on its feet.

A number of municipalities are already failing, which is very serious. Why didn't you mention that (such as Harrisburg, PA) in your interview?

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