Give credit to Meredith Whitney for sticking to her guns. The financial analyst just inked a deal with the Portfolio imprint of the Penguin Group to write a book -- "Downgraded: Why the Next Economic Crisis Will Be Local" -- about the dire straits of state and municipal finances. Back in 2010, Whitney made headlines, and caused an investor stampede out of munis, when she predicted hundreds of billions of dollars of municipal-bond defaults.
That hasn't happened. In fact, the total number of defaults actually fell last year. And many investors who were spooked by the grim predictions poured back into the municipal-bond market. Other investors were simply chasing returns, analysts say. The average long-term national muni-bond gained 9% in 2011, compared to a 2.1% gain for the S&P 500, according to Morningstar Inc., a fund research firm.
Still, muni-bond bears say these investments are still plenty risky. As part of the federal government's effort to reduce its massive deficit, several lawmakers -- as well as President Barack Obama -- have proposed cutting or eliminating the tax break on income from municipal bonds for high earners; as of now, muni-bond income is tax-exempt. Other analysts, including those from BlackRock Inc., say there's plenty more downgrade danger ahead, with the number of "super downgrades" of muni bonds -- downgrades of two or more notches -- expected to accelerate through 2012.
Here's a look at five that were on the edge in early 2011, and how they're doing now.
Whittier, California
What made people nervous: In 2007, this city in Orange County issued $15 million in bonds through its redevelopment agency to finance low- and middle-income housing projects.! But lik e many cities, Whittier experienced a downturn after the housing market bust. At one point in 2008, the bonds were trading at 60 cents on the dollar.
What happened: A California Supreme Court ruling in January will allow the state to end redevelopment agencies, which is quashing planned projects statewide. The upside: More money left over for bondholders. The bonds are trading near face value again.
Lesson for investors: The fate of bondholders and the projects they finance don't always go hand-in-hand.
American Folk Art Museum, New York City
What made people nervous: The museum issued $31 million in bonds in 2000 to fund a move to a new building in midtown Manhattan. But attendance fell off a cliff during the recession, and creditors wondered whether they were ever going to get paid. At one point, the bonds were trading at 55 cents on the dollar and sported a yield of nearly 30%.
What happened: The Museum of Modern Art bought the American Folk Art Museum's building, allowing it to retire its debt at par value. Risk-tolerant bond investors could have made a killing. The American Folk Art Museum, however, had to put much of its collection in storage. "We're on our way up again," says Linda Dunne, acting director. "The fact that we're debt-free is huge" and has helped attract new donations, she says.
Lesson for investors: Bonds backed by prime real estate can sometimes be a good deal, even if the entity that received the bond proceeds is having trouble.
Borrego Water District, outside San Diego
What made people nervous: Selling houses in the remote desert proved difficult in a slowing economy, the developer told SmartMoney last year.
What happened: About $9.5 million of bonds were issued to fund the development. The bonds are in default. The water district's lawyers started foreclosure proceedings against all property owners who were delinquent in paying their taxes.
Lesson for investors: Three words: location, location, location. The developer didn't return a call for comment.
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