Wednesday, March 12, 2008 1 comments ++[ CLICK TO COMMENT ]++

US Government Hearing Over Municipal Bond Rating

The American Congress will be holding hearings on rating of municipal bonds. The issue being discussed is whether municipalities, which includes public-private partnerships, quasi-government entities, and so forth, should be rated using the same scale as corporate debt. Presently, the munis are rated on the sovereign (national government) debt scale. Those who are not familiar with the bond ratings right now (I suppose this would be casual investors because debt investors would clearly know the differences and what they mean) may be confused with having multiple scales. The municipalities are of the view that they are paying too much since they are being under-rated.

It's not clear to me if the government is seeking one scale to rate everything or if they just want to rate municipalities on the corporate scale, excluding national governments.

The question if one scale is adopted is, of course, whether municipalities are under-rated or whether corporations are over-rated. Does a AAA-rated corporation, like G.E., mean the same as a AAA-rated government like the US government?

On another note, although the government likely doesn't care about this but chances are another new scale will be introduced in the future to handle structured finance products. It looks like the rating agencies are moving in that direction given all the confusion over ABS of various types and CDOs. If one thought there was confusion over the municipality ratings, structured products are even worse. Needless to say, introducing an addtional scale runs counter to the argument made by the government for muni bonds.

As for the impact on monolines, those that rely on the AAA ratings would suffer somewhat if municipalities are rated higher (say an intrinsic AAA rating). However, the impact will likely be less than some imagine because something like 70% of so-called muni bonds are entities that likely won't be rated AAA under a single scale. The real benefit of muni bond insurance is not with the high quality muncipalities or with GO (general obligation) bonds (which generally have taxing power); rather it's with small towns, public-private partnerships, and so forth (these would never get a AAA rating either because they are too risky or they can't afford to pay for the rating so would rather pay a small spread to the monolines). Historically, like any type of insurance, bond buyers value bond insurance not for the low-risk municipalities but for the uncertain entities.


1 Response to US Government Hearing Over Municipal Bond Rating

March 12, 2008 at 10:27 AM

Barney is really in a huff. He's given the insurers a month (?!) to "get their act together", whatever that means. He's even talking about the Fed gov't insuring muni's (though that sounds like a Constitutional can of worms).


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