A few powerful members of Congress have got it in their heads
that it would be a good idea to shake up the municipal bond market.
It’s a bad idea, especially at time when most markets are
troubled.
These bonds — interest bearing notes from state and local
governments — tend to pay low, predictable interest rates. Most
municipal bonds go to pay for workaday public infrastructure —
boring but necessary things like sewage treatment plants and
highway interchanges. Given their staid nature, it’s not surprising
that the municipal bond market has remained much more stable than
other parts of the currently chaotic financial system.
House Financial Services committee chair Barney Frank and
Capital Markets subcommittee chair Paul Kanjorski, among others,
want to change that by imposing a new regulatory regime on the
municipal bond market. A bill they’ve proposed, the Municipal Bond
Fairness Act (which the Financial Services Committee considered
Wednesday), would give the government broad new powers to oversee
the ratings firms that deal with municipal debt.
Although the legislative language doesn’t look very radical, the
bill essentially mandates that bond raters focus on default risk
(the risk that it won’t get paid) and use that to make municipal
bond ratings mirror corporate bond ratings. Ratings matter because
they determine interest rate a government will have to pay and,
thus, set an effective cap on the total amount of debt that a
government can issue, as well as the revenues it will have to raise
to service the debt.
Greater ability to issue bonds at lower interest rates would let
government do more. People who like small government have reason to
be worried about this.
SO DO BOND investors. If corporate and government debt were held to
equal standards based on default risk, this would result in
significant “grade inflation” for all state and local government
debt.
The bill’s sponsors insist that municipal bond investors do
almost always get paid. No state has defaulted on its debt since
the 19th century. Cities, counties, and independent authorities
have gone bankrupt but state governments have often helped out.
Sometimes — in Washington, D.C. in the 1990s and New York City
in the 1970s — a higher level of government sets up a control
board in order to help reign in a city’s free-spending ways. These
systems also protect investors.
But this starry eyed optimism glosses over the fact that major
governments — Orange County, California most prominently — have
entered bankruptcy court without any substantial bailout assistance
from state or federal authorities.
Other substantial risks exist when investing in government debt.
A legislature that authorizes an appropriation or creates a revenue
stream for local government can almost always take it away whatever
it gives without much warning. And mayors and governors who would
get unanimous support from corporate boards can find themselves
voted out of office for all sorts of things totally unrelated to
fiscal management.
IN OTHER WORDS, corporate and municipal debt may well be different
enough to warrant disparate treatment.
Given the recent collapse of apparently stable companies ranging
from Bear Stearns to Countrywide, it’s clear that at least some
corporate debt analysts haven’t been doing their jobs very well.
Analysts also missed the early signs of mismanagement and risky
investing strategies that lead to Orange County’s own
bankruptcy.
Quite possibly, the entire way the United States rates bonds
needs an overhaul. It’s even conceivable that, as Frank and
Kanjorski argue, municipal bonds really should have broadly higher
ratings than they do today. But the market, not the government,
should and will determine that.
Especially in the midst of widespread financial market chaos,
simply mandating broadly higher ratings for municipal bonds doesn’t
make any sense.
