Municipal Revolt

"Does Wall Street underrate Main Street? A growing number of states and cities say yes. ... A complex system of credit ratings and insurance policies that Wall Street uses to set prices for municipal bonds make borrowing needlessly expensive for many localities, some officials say. .. States and cities rarely dishonor their debts. ... But some officials complain that ratings firms assign municipal borrowers low credit scores compared with corporations. Taxpayers ultimately pay the price, the officials say, in the form of higher fees and interest costs on public debt. ... California ... is soliciting support from other municipalities for a letter it intends to send the ratings agencies, arguing that municipal bonds should be rated on the same scale as the one used for corporate bonds. ... Officials at ratings firms and bond insurance companies defend the system, saying it gives investors the information they need to buy bonds with confidence. The recent turmoil, they say, highlights the need for insurance. They further add that rating municipal bonds like corporate debt would not save taxpayers much money, if any. ... The plunging fortunes of bond guarantors, meantime, have cast doubt over the value of the insurance polices municipalities buy. 'We are learning essentially that the emporer may have no clothes, that there is no real reason to require these towns to have insurance in many instances,' said Richard Blumenthal, the attorney general of Connecticut, who is investigating the ratings firms on antitrust grounds. 'And it simply serves the bottom lines of the ratings agencies, the insurers, or both'. ... Ratings firms, bond insurance companies and some bond investors defend the separate ratings scales, arguing that it allows investors to make distinctions among various debt and ultimately, set appropriate interest rates. ... Gail Sussman, the Moody's executive in charge of public finance ratings, likened the firm's dual ratings scale to a ruler that measures in inches on one side and centimeters on the other", my emphasis, Julie Criswell and Vikas Bajaj at http://www.nytimes.com/, 3 March 2008.

What a pile of self-serving claptrap from Moody's Sussman. I have an idea: end letter ratings. Instead give bonds classes by expected default rate, less than .001 over ten years, less than .002 over ten years, etc.. If this means Moody's and S&P have 50 classes, so be it. At least we will be able to see how good these organizations are based on their ex ante default rate estimates. Unwittingly, officials at the rating agencies let the cat out of the bag, "the system .... gives investors ... confidence", i.e., it's a con game.