The woman who called Wall Street's meltdown
Star bank analyst Meredith Whitney says the economy is about to sink into a deep recession.By Jon Birger, senior writerLast Updated: August 4, 2008: 11:53 AM EDT
"I feel like I'm at the epicenter of the worst financial crisis in history," says Meredith Whitney, at home in New York City. Whitney, in Central Park, where she often runs, made her name with accurate predictions of losses and write-downs. Whitney met her husband, pro wrestling star John Layfield, when they were both talking stocks on Fox News. Whitney, in a luxury box, watches the wrestling action at the WWE's Great American Bash at the Nassau Coliseum in July.
(Fortune Magazine) --

It's the first time I've seen Wall Street's toughest analyst look rattled. I'm sitting ringside at the WWE's Great American Bash at New York's Nassau Coliseum with Meredith Whitney - the Oppenheimer & Co. analyst renowned for her smackdowns of America's biggest banks. Though she and I are there to see her husband, pro wrestling star John Layfield ("JBL"), the evening's most compelling match turns out to be not Layfield's but a brutal-looking showdown between rivals Chris Jericho and Shawn Michaels. Midway through the bout, Michaels appears to suffer a bloody cut near his eye and begins stumbling around the ring as if he's just been lobotomized.

I'm more bemused than worried - every match thus far has ended with the vanquished looking broken and semiconscious. Whitney, however, is shielding her eyes. Maybe it's because her husband once sustained a cracked vertebrae during a match, but she's absolutely convinced that this time around, the semichoreographed mayhem in the WWE ring has taken a sickeningly painful turn. "No, I'm telling you, it's real," Whitney says of Michaels's injuries, which included (or so Jericho would claim) a detached retina. Or maybe not: "He's fine," WWE vice president Gary Davis would later tell me.

Good thing for investors that Whitney takes a more skeptical approach to banks than to pro wrestling. In less than a year she has transformed herself from a Wall Street backbencher - someone once known less for her research than for her marriage to Layfield and her stint as a stock commentator on Fox News - into the most influential stock analyst in America. And certainly the most bearish.

Whitney's rise to prominence began last October when she dropped jaws from New York to London with her audacious (yet spot on) prediction that Citigroup (C, Fortune 500) would be forced to cut its dividend to prop up its leaky balance sheet. She followed that call with forecasts of more losses and write-downs at the likes of Bank of America (BAC, Fortune 500), Lehman Brothers (LEH, Fortune 500), and UBS, as well as some insightful tangents on how the implosion of the bond insurers would threaten banks' bottom lines. Sometimes she seems steps ahead of management. On a Merrill Lynch conference call in mid-July, she asked CEO John Thain why the company wasn't unloading damaged assets and boosting capital. Thain demurred, but less than two weeks later, Merrill (MER, Fortune 500) did just that. It agreed to sell more than $30 billion of CDOs (collateralized debt obligations) for 22 cents on the dollar and sold stock to raise $8.5 billion in fresh capital.

Whereas her peers keep searching for some sort of light at the end of the tunnel, Whitney thinks the tunnel is about to collapse. Bank stock investors will get crushed if they jump back in now, she contends, because the banks are facing much, much bigger credit losses than what they've reported so far. Moreover, Whitney is convinced that the economy is about to sink into an "early 1980s-style" recession that will devastate the 10% of the population that became overextended during the housing boom. "It feels like I'm at the epicenter of the biggest financial crisis in history," says Whitney.

This isn't ego talking. "She definitely moves markets," says Gus Scacco, an institutional fund manager for AG Asset Management. An executive with a top hedge fund goes so far as to compare Whitney's influence to that of former Goldman Sachs chief strategist Abby Joseph Cohen in the late 1990s. "It's gotten to the point," the executive says, "where Meredith can't opine or write anymore without moving stocks."

Whitney's insights haven't always translated into lucrative investment picks. Based on the performance of her buy and sell recommendations relative to her industry peer group - what analyst tracker Starmine refers to as an analyst's "industry excess return" - Whitney's stock picking ranked 1,205th out of 1,919 equity analysts last year and 919th out of 1,917 through the first half of 2008. That said, evaluating Whitney solely on the timing of her buys and sells misses the point. It's not just that she's bearish on the entire banking industry. What makes Whitney so interesting is the brutality of her arguments and the evidence she summons in making them.

Whitney warned last year - and continues to warn today - that the "incestuous" relationship between the banks and the credit-rating agencies during the real estate bubble will have a long-lasting impact on banks' ability to recover. With Moody's and Standard & Poor's now trying to make up for past wrongs, the pace of downgrades on mortgage securities shows no sign of slowing: There were $85 billion in mortgage securities downgraded in the third quarter of 2007, $237 billion in the fourth quarter, $739 billion in the first quarter of this year, and $841 billion in the second quarter of 2008.

This is a problem, because every time their portfolios are hit by significant credit downgrades, banks are forced to improve their capital ratios. Often that means issuing reams of new stock, which leads to serious dilution, something shareholders at Citi, Merrill Lynch, and Washington Mutual (WM, Fortune 500) can unhappily attest to. "You're going to have this stealth pressure on bank balance sheets until you start to see the ratio of downgrades to upgrades change," says Whitney. "It's something people don't talk about."


Obviously the financial companies she covers aren't thrilled with all the dire talk. Whitney got an earful from Wachovia (WB, Fortune 500), she says, when she downgraded the stock to "underperform" in July. Investors aren't always thrilled either. She says she's received one death threat and hundreds of abusive e-mails and phone calls. But at least now there's a grudging respect for her work. "What do you do when your biggest tormentor keeps being right?" one ex-Citigroup executive asks when queried about Whitney. "You got to give it to her - she figured it out."

Despite her unremitting bearishness, Whitney has probably never had better access to bank management. This is a bit surprising, given that being a renegade bank analyst used to be a one-way ticket to the unemployment line. (Just ask industry vets like Michael Mayo.) Nevertheless, Whitney has been landing one-on-one meetings with the likes of Bank of America CEO Ken Lewis, Merrill Lynch CFO Nelson Chai, and American Express CEO Kenneth Chenault.

Of course, a cynic might counter that it's hardly shocking that a bunch of middle-aged male bank executives would spare time for a glamorous analyst with a megawatt personality and a jock-celebrity husband. "She always had more personality than anyone else," offers former Commerce Bancorp CEO Vernon Hill.

But this explanation for Whitney's influence and access is belied by her following among money managers who treat her latest research reports like gospel. "What I like is, she's got conviction," says Scacco. "She was early, she was right, and she wasn't shy about saying it." The most recent conference call Whitney hosted for Oppenheimer's institutional clients drew as many callers - about 500 - as Exxon Mobil typically gets on its quarterly earnings calls.

Plus, as warm and engaging as Whitney can be in person, she's an utter killjoy when the conversation turns to banking and the economy. "What's ahead is much more severe than what we've seen so far," she warns a standing-room-only crowd of money managers at a May lunch meeting. Once she gets rolling, Whitney morphs into a kind of dark sage - the anti-Abby Joseph Cohen, if you will - whose doom-and-gloom views capture the prevailing mood of today's market about as perfectly as Cohen's unapologetic bullishness caught the exuberance of the late 1990s. When one shell-shocked lunchgoer presses Whitney for a glimmer of hope, she has none to offer. Asked by another money manager whether she has any doubts, Whitney concedes only one: "While my loss estimates are much more severe than those of my peers, my biggest concern is that they're way too low." That was May. By mid-July, bank stocks were down another 20%. Today, of the 14 financial stocks she covers, she rates five underperform and the rest market perform.

Just who is Meredith Whitney, and how the heck did a little-known analyst from a second-tier firm become the oracle of the bear market? The first question is simpler to answer. Whitney, 38, grew up in Bethesda, Md., one of three daughters born to Richard Whitney, a venture capitalist and onetime official in Richard Nixon's Department of Commerce (but not part of the famous Whitney clan that includes Eli and John Hay Whitney), and Barbara Gentry, an executive recruiter. She prepped at Lawrenceville, graduated from Brown University in 1992 (Whitney and I overlapped at Brown but didn't know each other), and has been working in Wall Street research pretty much ever since. Her only break from the Street was her stint at Fox's Bulls and Bears from 2003 to 2004. She took the TV gig, she says, after a noncompete with a former employer barred her from immediately accepting another analyst job.

Older sister Wendy Taylor says Meredith has always been one part workaholic and one part Ms. Popularity. It isn't an easy combo to pull off, but Whitney perfected the balancing act at a young age. Case in point: She was once the youngest paper carrier in Washington Post history, landing the job at age 8. A self-described "route baron" - she grew her earnings to $200 a week by buying up other kids' paper routes - Whitney hit on a creative way to cope with the extra workload on Sundays, when the heftier papers took longer to deliver. "I would have slumber parties on Saturday nights, so I had a work force to help me in the morning," she says. "We'd play music, and Mom would make pancakes in the morning." Did she pay her friends for their help? "No way. But they kept coming back."

Thirty years later little has changed. Whitney still works weekends but takes her fun seriously too. "I always tell people Meredith has never met a conga line she didn't lead," says Taylor, who can't visit her sister in Manhattan without being dragged out dancing till the wee hours of the morning. "She's truly larger than life."

Where does Whitney get all her energy? Exercise and (relatively) clean living, she says. She recently gave up coffee, and she works out twice a day, often under the supervision of rapper 50 Cent's personal trainer, whom she met last year at Bikini Boot Camp. (It's a fitness retreat, not a reality show. That said, Whitney's longtime friend Mary Fitzgibbon reveals that she and Whitney almost became reality-show fodder 15 years ago. A Lawrenceville buddy who was a producer for talk show host Maury Povich persuaded them to appear on a "when good girls go bad" episode. "Meredith thought it would be funny," Fitzgibbon recalls. Whitney's mom did not and talked them out of it just hours before taping. "Her mom called up and said, 'Are you girls out of your minds? You're just starting careers!'")

Whitney is fond of playing matchmaker, but she wasn't making much headway in her own personal life until she met Layfield. In addition to playing one of the WWE's most entertaining villains - he's basically the J.R. Ewing of pro wrestling - Layfield moonlights as a stock market pundit on Fox News, which is where he and Whitney first met. The relationship got off to a rocky start when Whitney mocked Layfield on air for recommending bank stocks at a time when the Fed was hiking rates. But Layfield wasn't discouraged - he's taken worse hits - and the couple married in 2005.

With most of these tales, it's the beauty who reforms the beast, not the other way around. And yes, Layfield does credit his wife for smoothing out some of his Texas-country-boy rough edges. "I know what fork to use now at the dinner table, and I drink my beer from a glass," he told the Sunday wedding section of the New York Times back in 2005. Of course, as with anything WWE-related, it's not always clear where reality ends and fable begins. Layfield didn't exactly grow up the son of a dirt farmer - his dad was CEO of a community bank - and when I ask him about the fork-and-beer story, Layfield smiles and concedes he might have been exaggerating.

Whether any of Whitney's upper-crust upbringing actually rubbed off on Layfield, it's apparent the WWE has rubbed off on Whitney. Her insider's view has given her great respect for pro wrestlers' work ethic and their willingness to lay everything on the line as performers, athletes, and stuntmen. What might have seemed risky - e.g., putting out a critical report on a sacred cow like Citi - no longer feels so dicey. "I think when you're around successful people like that, it makes you more renegade," she says.

Another eye opener for Whitney has been how gracious most wrestlers are - at least when the cameras aren't rolling - in comparison with the viper-pit culture on Wall Street. It sounds absurd - the world of high finance being less collegial than an industry in which employees belt each other in the face. But based on the time I spent backstage before the Great American Bash, Whitney has a point.

The wrestlers I met - from John Cena to Mark Henry to Paul "Big Show" Wight - all greeted Whitney like family. Henry, who plays a particularly nasty brute in the WWE story line, could not have been any nicer. For Whitney the upshot is this: She's much less inclined to take guff from Wall Streeters intent on berating her for predictions they don't like. "Life's too short," she says.

About that second question: How did Whitney go from virtual anonymity to Wall Street stardom in a matter of months? Her Citigroup call was certainly the launching pad, but Whitney's ascent didn't happen in a vacuum. Her prominence may be the best proof yet of how much the equity research game has changed since the start of the decade.

The catalyst was the settlement imposed on Wall Street in 2003 by then - New York Attorney General Eliot Spitzer, who alleged that the lure of underwriting and M&A fees was preventing analysts from giving honest appraisals of companies that were also their firms' investment-banking clients. Spitzer's solution: Erect a legal barrier that prevents analyst compensation from being tied to investment-banking revenue.

Since 2002 the percentage of ratings that are buys has fallen from 75% in 2000 to 50%, according to Starmine and Bloomberg data. The percentage of sells has risen from 1.5% to 6%. Nevertheless, it's hard to assess how much credit for this turnabout should go to the now disgraced former attorney general. The increase in sell ratings coincided with a downturn in IPOs and other stock offerings, meaning there's less for analysts to be conflicted about. "Now that corporate finance has dried up, research is freer to express its opinion," says Richard Bove, a bank analyst with Ladenburg Thalmann & Co. and a 30-year Wall Street veteran.

Another factor emboldening analysts has been the emergence of hedge funds as the biggest source of trading-commission revenue. Hedge funds crave "actionable" information, and unlike mutual fund managers, they're just as happy betting that a stock will fall as they are betting that one will rise. So, says Bove, "the analyst had better tell them what they don't like as well as what they like."

Of course, what Whitney doesn't like is just about everything these days. Her bearishness has deep roots. In fact, she was the first analyst to sound the alarm loudly about subprime mortgages, predicting back in October 2005 that there would be "unprecedented credit losses" for subprime lenders. The problem, as she saw it, was that loose lending standards and the proliferation of teaser-rate mortgage products had artificially inflated the U.S. home-ownership rate to 69% from the more natural level of 64%.

A lot of the new homeowners were in over their heads. They'd put little or no money down and thus had little incentive - and often little ability - to keep making their monthly payments when home prices started to fall and their teaser rates got bumped up. "Low equity positions in their homes, high revolving-debt balances, and high commodity prices make for the ingredients of a credit implosion, particularly at this point in the consumer cycle," Whitney wrote. That report didn't turn her into a star - though it should have - but it did land her an invitation to present her findings to the FDIC.


What Whitney didn't fully appreciate back in 2005 was how the proliferation of interest-only, negative-amortization, and other exotic mortgages would transform many prime borrowers into subprime credit risks. As she wrote last December, the crucial mistake many lenders made was relying on FICO credit scores to gauge default risk, regardless of the size of the down payment or the type of loan. Many prime customers who took on mortgages with 90% or 100% loan-to-home-value ratios (LTVs) are now "performing closer to subprime loans," she wrote. The reason: Any borrower who's upside down in his mortgage - i.e., the size of his mortgage is bigger than the value of his home - is likely to make car and credit card payments before paying his home loan. "The hierarchy of payments has totally shifted," Whitney now says.

One of Citigroup's problems was that of all the banks, it had the greatest exposure in dollar terms to high-LTV mortgages. When housing prices turned south, the delinquency rate on Citi's home loans soared - rising 53% during the third quarter of 2007 (over the third quarter of 2006). Whitney says it was obvious that Citi would have to shore up its balance sheet. The bank's $10.8 billion in annual dividend payments was a clear source of potential savings. Less than three months after Whitney put out her report, Citi announced a 41% dividend cut designed to save the company $4.4 billion a year.

Whitney's current concern is that banks aren't slashing costs and cutting losses in their loan portfolios fast enough. On the cost side, she says, banks have yet to come to terms with the disappearance of the securitization market, which she believes will stay in hibernation for the next three years.

Why does this matter? From 2001 through 2005, for every dollar of bank capital used to make mortgage loans, ten were supplied via investors in mortgage securities. All that secondary-market capital is now sidelined, but the staffing levels of bank lending departments don't yet reflect it. By Whitney's reckoning, banks have laid off about 7% of their employees; she thinks the cuts need to reach 25%. "These companies have got to resize their businesses," she says. "Right now their expenses do not match their revenues."

She also argues that banks need to "get real" about how they're valuing their problem mortgage-related debt, much as Merrill Lynch has now done. And her idea of "real" is pretty drastic. Whereas most banks are estimating 20% to 25% peak-to-trough declines in housing prices, the Case-Shiller housing futures traded on the Chicago Mercantile Exchange portend a much steeper 33% decline, she points out. In fact, Whitney thinks the actual declines will be worse - closer to 40% - because of the loss of the securitization market and the paucity of mortgage credit available. And that means more defaults: "The consumer's ability to refinance his way out of trouble has diminished greatly."

This is where Whitney's critics start licking their chops. Thomas Brown, a veteran bank analyst and co-founder of bankstocks.com (with Hill, coincidentally), disagrees sharply with Whitney's contentions that banks need to rid themselves of problem loans and that their stocks won't rebound until the write-downs abate.

Brown counters that the numbers Whitney keeps trotting out are actually lagging indicators. "During the last credit crisis the stocks hit bottom in November 1990, and the losses and nonperforming assets didn't peak until well into 1991," he says. "Every cycle there's one analyst who races to be the most bearish, and this time it's her. Honestly, I think we'll look back and see that Meredith Whitney's credibility peaked on July 15" - the day many bank stocks hit their low point for the year (so far at least).

Brown goes a step further, alleging that it's "incredibly arrogant" of Whitney to tell banks and investment banks either to unload their problem loans and mortgage securities or to "get real" about how they're valued. He says there's plenty of history to indicate that holding tight may be the wisest course of action. "In the last cycle," Brown says, "Morgan Stanley made a fortune buying written-down commercial real estate assets from banks at 40 cents on the dollar." What peeves Brown most about Whitney is her unwillingness to assign a fair market valuation for the stocks she's trashing: "The only explanation I can see is, she has no idea how to evaluate the possible downside risks."

To be fair, Whitney has never said bank stocks are worthless. She would buy Wachovia at $5, for instance. (It's now $16.) But with his salvo Brown has actually restated, albeit pejoratively, a core part of Whitney's thesis. If she has no idea how to properly value bank stocks right now, it's because the metrics don't work. Price-to-earnings ratios are useless when earnings are nonexistent. And valuing banks on price-to-book ratios is just as futile. Those book values - which reflect underlying assets and liabilities - are moving targets. "Citibank has lost 50% of its book value since last year," Whitney says. "The point is, I do not think we are near the end of write-downs, so I continue to see capital levels going lower, capital raises diluting existing shares further, and stocks going lower."

Another negative: two little-talked-about regulatory changes Whitney says will stymie banks' recoveries. One is a new accounting rule known as FAS 141R. Given the depth of the crisis, Whitney expects to see bank regulators arranging shotgun marriages between well-capitalized institutions and foundering ones. Problem is, any such deals would have to happen before FAS 141R takes effect in December. The new rule, she says, "will make it almost impossible to do bank mergers." The rule demands that an acquirer not only immediately mark to market the portfolio of the company being bought - and remember, bids for mortgage assets are now few and far between - but also mark to market its own portfolio as well. "Nobody's going to want to do that," Whitney says.

Another regulatory change that may wreak havoc: Starting next year, the Office of Thrift Supervision will bar credit card issuers from using outside credit information to reset interest rates. For instance, Wells Fargo couldn't increase the rate on your Visa just because you were late on an electric bill. While Whitney thinks the OTS proposal is well intentioned, she's convinced that it will force banks to reduce the amount of credit they extend to consumers, dimming a business that has been a rare bright spot. With their credit lines trimmed, consumers will cut back even more on spending, deepening the recession. "When this takes effect," she says, "it's basically going to amount to a pay cut for the average American consumer."

Whitney's ability to find consumer peril in a proposal ostensibly so consumer-friendly speaks volumes about the darkness of her view. Indeed, she's so far out on a limb and so unequivocal in her bearishness, it's hard to envision how she could reverse course without losing credibility. It's a predicament similar to the one Abby Joseph Cohen faced in 2000 and 2001 - one that left her with egg on her face when the stock market faltered.

Fitzgibbon says she recently asked Whitney how it would all end, and Whitney's answer was fatalistic: "I'll make a bad call, and that'll be it." When I ask Whitney what's next for her, career-wise, she isn't sure. Getting into management holds some interest. Joining a hedge fund - a common next step for star analysts - does not. "All I know is, I want to do something big. I want to earn the right to be at the table with the smartest people."

Whatever her future holds, Whitney says she doesn't spend time fretting about whether her epic call on banks might be wrong. "Look, I always worry about what I might have missed, which is why I work so many hours and get so little sleep," she says. "But the numbers speak for themselves. And what they're all saying is, this is far, far from over."

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