Bond Blues

State budgets are on the verge of a blowup

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When Meredith Whitney, the financial analyst who predicted the banking meltdown, speaks, ears perk up. Her latest proclamation: Thanks to unfunded pension liabilities and declining tax revenues, 50 to 100 states and cities or other municipalities will soon default on loans totaling hundreds of billions of dollars. Nervous investors are already fleeing municipal bonds, which have long been considered a safe haven. Since early November, according to Lipper, individuals have pulled $23.6 billion out of muni-bond funds.

Like so many economic trends, this one will be bifurcated. While states with high unemployment and low growth like Michigan are in danger, others like Iowa and Virginia are poised to do better. Since 1970, there have been 55 muni defaults on rated bonds, according to Moody's. Whitney predicts nearly twice as many this year alone. That's not a black swan. That's a flock.