Friday, February 11, 2011

A New Enemy of the People

by Larry M. Elkin, CPA, CFP

In Henrik Ibsen’s 1882 play An Enemy of the People, Dr. Thomas Stockmann tries to tell his town that its popular tourist baths are so polluted that they sicken those who visit them for a cure. The town, led by Stockmann’s brother the mayor, brands Stockmann an alarmist rather than face the expensive repairs that must be made.

The world has changed since 1882, but people have not. We still tend not just to blame the bearer of bad news, but to vilify him – or her, in our modern times.

Meredith Whitney is a Wall Street analyst who was best known, until recently, for having been part of the minority that forecast big problems for the banking industry before the credit crisis began in earnest. She has since become even more prominent because of her prediction that scores of America municipalities, as many as 100 of them, are in such bad financial condition that they may default on their debts. This opinion has thrown the municipal bond market into turmoil. It has also triggered attacks against Whitney from players in that market.

Whitney may be correct, or she may be mistaken. Analysts are not oracles. Their opinions are just opinions. The choice to listen or not lies with us. When people’s pocketbooks are threatened, however, it is sometimes hard for them to keep this in perspective. Often, those with a great deal to lose will strike back, rather than say “thanks for the heads-up.”

Rep. Patrick McHenry, R-N.C., is striking back. He tried to haul Whitney in front of his House panel to justify her negative comments on the municipal bond market. Whitney has declined to appear in front of the House Oversight and Government Reform Committee, having astutely decided she has more pressing business than to appear as a punching bag before the cameras. McHenry darkly warned, however, that “she’s going to be part of the hearing, whether or not she participates.”

Instead of targeting Whitney, McHenry might do more good by focusing on the seriously flawed manner in which state and local governments manage their finances, including the information they give or don’t give to the people buying their bonds.

After all, Whitney is not responsible for the alleged misconduct that prompted the Securities and Exchange Commission to bring securities fraud charges against the state of New Jersey. Nor is she responsible for the issues that led the SEC to investigate bond issues in Illinois, Rhode Island and the city of Harrisburg, Pa.

It is not Whitney’s fault that municipalities from one end of the country to the other have underfunded their pension plans, or that they have made costly promises, mostly but not exclusively to unions, that they are unlikely to be able to keep. She did not write the laws and contracts that put the city of Pittsburgh, with an aging and shrinking population, in a $700 million hole.

Besides questions of blame, in the larger scheme, it is important to remember that financial Cassandras are not always correct – nor would anyone expect them to be. Even when they are right, it does not necessarily follow that an investor will profit from taking their advice. Anyone who understands investing should know this, including bond buyers, bond sellers, regulators and even legislators like McHenry.

Consider the case of Nouriel Roubini. Roubini, an NYU economist, is best known for predicting the mortgage meltdown as early as 2006. At the time, his voice was a lone one, and his opinions earned him the nickname “ Dr. Doom.”

Of course, it was obvious when the markets crashed in late 2008 that Roubini had been right. At that point, he correctly predicted that we were about to experience a deep recession and a slow, painful recovery.

By early 2009, as the markets slid lower – the S&P 500 Index had dipped below 700, briefly – Roubini predicted that a further decline to 600 was a certainty, and a drop to 500 was possible. He advised stricken investors to stay away from stocks for the rest of 2009.

Most people who took his advice at that point suffered for it. Even as he made this prediction, the market had begun a rapid rally that carried the index up to 1,115 by the end of the year – a rise of more than 60 percent from the market bottom. Most of the other risky assets Roubini warned against rallied too. This month, the S&P has been trading above 1,300.

Roubini continues to be known as Dr. Doom.

As it turns out, Roubini was right about the economy but wrong about the consequences in the stock market. That isn’t unexpected. Nobody can really claim to predict short-term moves in the markets anyway, which Roubini now has reason to remember. Economists are paid to forecast the direction of the economy, not investments.

Does this mean Congress should investigate Roubini? Not at all. He is entitled to his opinions, on both the economy and the markets, just as Whitney is entitled to hers and I am entitled to mine. I may respect people like Whitney and Roubini enough to pay attention to their thoughts – or I may not – but in the end, it is up to me to decide which advice to follow.

There are many things wrong with the municipal finance market. Meredith Whitney is not one of those things, no matter her accuracy or lack thereof. There are a lot of people who would rather not hear what she has to say. Branding Whitney an enemy of the people says much more about the rest of us than it says about Whitney.

As Ibsen’s Dr. Stockmann put it, “the strongest man in the world is the man who stands most alone.”

For more articles by Larry M. Elkin on financial, business, and other topics, view the Palisades Hudson newsletter, Sentinel, or subscribe to his daily opinion column, Current Commentary.

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