For mysterious reasons, municipal governments that have never defaulted on anything (and can, unfortunately, tax the living daylights out of their citizens to pay for even the most wasteful government spending) pay financially shaky companies to “insure” their municipal bonds, so that the ratings agencies will give the bonds a better rating.
(In overseas markets, the ratings agencies admit that pretty much any state won’t default; but here in the U.S., they claim that states vary widely in their creditworthiness and risk, to create work for themselves classifying states by their risk).
But the companies that provide the “insurance” themselves are at a serious risk of defaulting, because they stupidly insured tons of risky subprime mortgage-backed securities that the ratings agencies claimed were low risk. But since the ratings agencies don’t want to admit they were wrong about subprime mortgages, they won’t admit the full scope of this risk, and they thus long claimed that municipal bond “insurers” were in reasonably sound financial shape even when they were not.
Eventually, however, the risk to the municipal bond “insurers” became too obvious to hide from the public.
Now, the ratings agencies have belatedly begun to downgrade the bond “insurers.” Ratings agency Fitch has cut the rating of bond “insurer” Ambac Financial Group from a ludicrously rosy “AAA” to a still-too-rosy “AA.”
Earlier, the ratings agency Standard & Poor’s downgraded bond “insurer” ACA Financial, which has long been in danger of bankruptcy, from AAA to junk status (a CCC rating).
Standard & Poor’s has also placed three “insurers” — Ambac Financial Group Inc., MBIA Insurance Corp. and XL Capital Assurance Inc. — on a “negative outlook,” which means there is a one-in-three chance ratings will be cut in the next two years. Their ratings ought to have been cut long ago. The idea that these financially shaky “insurers” could insure a state’s debts is as silly as believing that a financially-troubled used car dealership can insure Microsoft.
These ratings agencies cannot even assess states financial conditions accurately. Several years ago, they stupidly threatened to downgrade Virginia’s credit rating if it failed to raise taxes. After Virginia raised taxes in 2004, it turned out the Virginia would have run a surplus even without the tax increase. (And, as Virginia House Appropriations Committee Chairman Vince Callahan noted, legislators and Governor Mark Warner promptly spent the entire pot of money raised by the tax increase, so the tax increase would have done nothing to cut the state’s (imaginary) budget deficit in any event).
Federal regulations that stand in the way of competition with existing ratings agencies need to be rewritten to enable new entrants into the ratings business.