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What Ever Happened to the Muni Crash?

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Market analysts make headlines when they make bold predictions. When those predictions are right, they can make an analyst's career. But even after you get one big call right, it can be incredibly hard to nail your next prediction.

That's the dilemma that analyst Meredith Whitney finds herself in right now. After having made a prescient call that the subprime crisis would spread to Wall Street's biggest banks, Whitney went on to predict a similar catastrophic event for the municipal bond market. Yet with munis having a calmer than average year so far in 2011, many now wonder if Whitney's call is the financial equivalent of crying wolf.

Munigeddon: 2011
Whitney built her reputation by raising concerns about the health of big banks like Bank of America (NYSE: BAC  ) . In late 2007, she wrote a report about Citigroup (NYSE: C  ) that predicted a dividend cut and the need to raise huge amounts of capital in order to bolster low reserves that were well below those of its peers. All of those concerns turned out to be correct, as the financial crisis played itself out over the next year and a half.

Late last year, Whitney did an interview for 60 Minutes in which she painted a dire picture for the municipal bond market. She predicted that over the course of 2011, 50 to 100 significant defaults totaling hundreds of billions of dollars would occur.

The reception those two calls got were quite different. Few believed Whitney's apocalyptic views on big banks, and just as few investors were willing to put money on the collapse in housing prices that would eventually prove to be a huge thorn in those banks' balance sheets.

But it's easy to understand why the state and local governments that issue most municipal bonds are in financial trouble. Falling tax revenues combined with unsustainable spending adds up to a ticking time bomb. Indeed, even Warren Buffett suggested that the next crisis would come from municipalities. With many muni bonds insured by private insurers, Buffett argued that local government leaders would have little incentive to sacrifice the financial well-being of their constituents to prevent losses at far-away bond insurance companies.

So where's the crash?
Thus far, though, the muni market hasn't met Whitney's timeframe. Bloomberg reported last week that defaults in 2011 were down a whopping 60% from this time last year, with 24 defaults involving securities worth just less than $750 million as of the end of June.

After withdrawing tens of billions of dollars from municipals last year and causing a huge drop in bond prices, the market has stabilized and even reversed course. The muni-tracking ETF iShares National AMT-Free Muni (NYSE: MUB  ) , which lost 6% of its value between last August and the end of 2010, has regained all that lost ground and then some when you consider the interest payments the bonds have made.

Where are the winners?
So if the muni default warning was a false alarm, who benefits most from it? The companies that insured muni bonds would get to keep premiums from municipal bond issuers while paying less money in loss claims. It may be too late for such a trend to do much good for bankrupt Ambac Financial, but other insurers, including Assured Guaranty (NYSE: AGO  ) and Berkshire Hathaway (NYSE: BRK-B  ) , would clearly reap the benefits. In addition, MBIA (NYSE: MBI  ) and Radian Group (NYSE: RDN  ) , which have also suffered from writing mortgage insurance, provide muni bond guarantees and so would benefit from less pressure on states and municipalities.

Of course, it's way too early to say that municipal bonds are out of the woods just yet. Whitney said as much in an interview with Bloomberg this month, saying that even if adjusting her timeframe proves necessary, nothing about her underlying arguments has changed.

What to do
With many worrying about higher taxes in the near future, the tax advantages of municipal bonds could become more valuable in the years to come. But tax considerations shouldn't take priority over protecting your capital. Although munis may not be on the brink of collapse just yet, they still carry risk -- and you need to be sure you understand that risk before you invest.

Unlike muni bond insurers, some stocks have tailwinds helping shareholders. The Fool has found five stocks for its portfolio that we think you should consider, too. Click on the link to have a free copy of our special report with those five names sent to you pronto.

Fool contributor Dan Caplinger remembers vividly every crash during his investing career. You can follow him on Twitter here. He owns shares of Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. The Fool owns shares of and has opened a short position on Bank of America. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't crash on you.


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  • Report this Comment On July 28, 2011, at 5:05 PM, rsd57 wrote:

    Whitney was way off base with her call on municipal bonds. Jefferson County, Alabama may file the largest bankruptcy but that was in the cards way before her call. She did manage to panic retail investors who lost a lot of money dumping good funds and bonds out the window in a panic. I hope the media including the Motley Fool keeps tracking this foolish call. She had little to no basis on making this prediction, and no expertise in municipal finance. So maybe at least the media can make some amends by properly pointing out her bad miss.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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