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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.
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
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.
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.
ability to issue bonds at lower interest rates would let government do
more. People who like small government have reason to be worried about
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
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.
-- 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
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.
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
IN OTHER WORDS, corporate and municipal debt may well be different enough to warrant disparate treatment.
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.
in the midst of widespread financial market chaos, simply mandating
broadly higher ratings for municipal bonds doesn't make any sense.
Eli Lehrer is a senior fellow at the Competitive Enterprise Institute.