In 2007 Meredith Whitney made her name for calling out Citibank and American banks generally as likely to suffer substantial losses from poor quality lending. The subprime collapse proved her thesis right within a year. In 2010 she went public with her next sector of potential weakness – US state and local government debt. In an interview on the US version of 60 Minutes she laid out her view that hundreds of billions of dollars of defaults would occur on state and local government debt. After her initial success with banks she has been held out as a failure on the basis that being too early and being wrong are indistinguishable.
It is often said that that bankruptcies happen slowly at first, then suddenly. The last five years since the 60 Minutes interview have been a slowly at first decline for many US governments. Detroit’s $18 billion bankruptcy in 2013 was the first major default this cycle, but now Puerto Rico looks set to take the crown at $72 billion. The Governor has publicly stated that the territory is insolvent and rapidly running out of cash. A combination of large pension deficits, ridiculously optimistic investment return forecasts for pension plans assets and a general attitude of kicking the can down the road on balancing budgets plagues many US state and local governments.
It is not just in the US where government debt issues are brewing. Ukraine is threatening to default as the war with Russia, the cessation of natural gas supplies and a collapsing currency all take their toll. The Greek debt melodrama has dominated investment discussions for the last month.
In the last financial crisis it was subprime residential lending that was the main cancer in the financial system. In the next crisis it may be that subprime governments are the cause of much of the carnage. We could be closer than many think to the point where the bond vigilantes say “enough” and rip away the availability of funding from subprime governments.