Meredith Whitney, noted banking analyst and commentator who now runs her own company, was interviewed in New York City's Bryant Park by her friend Leigh Gallagher of Fortune on Whitney's book "Fate of the States: The New Geography of Prosperity."
Whitney's thesis is that 17 states concentrated in the heartland of the United States, such as North Dakota and Texas, did not succumb to the housing bust of the mid-2000s and are moving away from the pack of states still mired in a growth recession. Gallagher, who grew up in New York suburbs, has written a book called "End of the Suburbs," which explains how the suburban business model also became over extended when suburbs could not sustain the growth that was needed to support their budgets.
Whitney picked up on that theme, noting that states back only pensions and bonds and that local entities had come to depend on states for 35 percent of their funding. She called the states "the house, the casino" that stranded local governments when they cut spending for services deemed not essential.
Whitney is famous for calls she made on Citibank in 2007 that led to a 7 percent decline in the stock in one day and in 2005, when she was one of the first to warn of a mortgage bubble. She also made significant negative calls on UBS, Lehman Brothers and Bank of America. Her fascination with the subject of municipal finance grew as she assembled a 600-page report that became the basis for the book, but required considerable reworking in order to make the book interesting to readers.
According to Whitney, the new growth would represent a departure from the mortgage finance model that was built around the issuance and securitization of mortgage by financial institutions that benefited from favorable regulation, which allowed the industry to export the mortgages to global investors.
She stressed that 71 percent of the U.S. economy consists of consumer spending, so states with healthy economies would benefit from increased consumer spending, whereas states that became too dependent on the taxes and fees that flowed from real estate transactions would not be able to support the social services, such as education, that are necessary to attract and retain industry.
Whitney identified a phenomenon that contributes to the decline of state and local governments with unsustainable funding. When people who have a choice as to where to live and work find that some budget elements are funded at 100 percent whereas social services are only funded at 50 percent, they leave, and this creates a negative feedback loop that is hard to escape.
She cited Detroit as an example and remarked that federal support through programs like the stimulus may have bought the city as much as a decade of time, but did not change the fundamental picture.
On the other hand, Minot, N.D., has grown so fast that a company had to leave because there weren't enough available workers. She noted that the availability of cheap energy enables German companies to save 20 percent as compared with the European Union, and that is fueling a comeback in manufacturing in the Midwest.
Gallagher asked about the state of the economy of New York, and Whitney responded that the City's economy is holding up well, and Mayor Bloomberg has worked to diversify it, but it is still heavily dependent on financial services. Elsewhere in the state, industry has experienced a protracted decline, with Buffalo shrinking by 50 percent since 1950.
At the end of the interview, the authors returned to the subject of housing and whether this time the policymakers would "get it right" or would "continue to push people into homes." Whitney gave an unhedged answer that resonates with a theme of these articles. The so-called "American Dream" has been distorted, and post-2008, it has been "an unmitigated disaster, with the government continuing to use Fannie Mae and Freddie Mac, along with Federal Reserve purchases of federally insured mortgage-backed securities to maintain a market based largely on refinances and mortgages for the wealthy, while household formation, which is needed to spur consumer spending, languishes."
She concluded that this federal program is just "another gimmick to paper over structural problems." The homeownership rate that policymakers so eagerly forced up near 70 percent is down to about 65 percent and likely to overshoot on the downside, and she warned against relying on the so-called "affordability index," the relationship between housing prices and household incomes, because she considers it to be "false."
The event reminded me of a conversation I had several years ago with a professor from Stanford who is a recognized expert on housing finance. I asked him what was going to happen to the suburban developments that have been established 40 or 50 miles in every direction from major cities based on the assumption that gas prices would remain low and jobs would remain plentiful.
The professor responded that those would have to be written down and the lenders would have to be bailed out, but it is alright to bail out banks every 15 years or so because they represent "valuable human capital."
As long as this view prevails in Washington — and it appears to inform the demands of so-called "bipartisan" housing lobbyists to restore the old housing finance system, backed by dodgy private capital and a full government guarantee — Whitney's presentation suggests that the Housing Industrial Complex will continue to impede the growth of the overall economy for the foreseeable future.
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