Governing Magazine/May 2008

FEATURE: BONDS

GIVING MUNI BONDS THEIR DUE

California's treasurer calls for an upgrade in the way credit agencies
deal with muni bond ratings.

Billions of dollars are at stake in the way state and local
governments are rated. That's how much they could save if municipal
bonds were rated on the same scale as corporate debt.
 That, anyway, is the position of California State Treasurer Bill
Lockyer and a group of like-minded officials who are asking the three
major credit rating agencies, which historically have treated
governments and corporations differently, to create harmonized systems
for judging default risk. Lockyer argues that Standard & Poor's,
Moody's Investors Service and Fitch Ratings give coveted AAA rating
scores to corporations, even when they have a much higher risk for
default than lower-rated governments.
 Lower credit ratings tend to translate into higher interest-rate
payments when an entity goes to the bond market to borrow money. If
California had an AAA rating instead of its A+ rating, Lockyer says,
it would save $5 billion over 30 years just on the interest payments
on bonds that are currently authorized but haven't been issued. "There
ought to be a consistent default analysis that is applied to every
issuer," Lockyer says. "The taxpayers are getting ripped off and we're
going to change the system."
 The rating agencies don't quite see it that way, but at least two of
them, Moody's and Fitch, seem open to changing their approach. Naomi
Richman, chief credit officer of Moody's global public finance group,
says that her company noted as early as 2002 that municipalities with
the same credit rating as corporations were at a lower default risk.
The consensus at Moody's, however, was to keep separate systems.
Moreover, governments weren't clamoring for a harmonized system
because bond market participants understood that AAA on the corporate
scale and AAA on the municipal scale didn't mean the same thing.
 But now, with the municipal bond market in turmoil and the
availability of bond insurance to boost a rating in question,
Lockyer's movement is gaining steam. His call for rating change has
garnered support from the top finance officers in 10 other states.
 Moody's seems willing to make some sort of accommodation. The company
is proposing a policy where municipal bonds are rated on the "global
scale" that also includes corporate issuers, in addition to receiving
a traditional municipal rating. The firm is currently soliciting
comments on that idea. Fitch has created a commission to study whether
similarly rated munis and corporations face different default risks
and to solicit input on harmonization from investors.
 Standard & Poor's has been resistant to change. S&P says that it
already uses a unified global rating system, a claim with which
Lockyer adamantly disagrees. In a memo released in March, S&P
acknowledged that municipal borrowers have rarely defaulted on their
debts in the past, but that the ratings governments receive are
justified by the financial challenges they face. S&P cited the
examples of two troubled jurisdictions: Jefferson County, Alabama, and
Vallejo, California.
 There's a chance, though, that S&P will be prodded to make a change
by congressional intervention. In March, Lockyer received a favorable
hearing before the House Financial Services Committee and its
influential chairman, Representative Barney Frank. "We're hoping,"
Lockyer says, "for voluntary reforms."
 For more on muni bond ratings, check out John Petersen's column on
page 79.
--Josh Goodman

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