Committee Passes Frank's Ratings Bill

WASHINGTON - The House Financial Services Committee unanimously passed the "Municipal Bond Fairness Act" yesterday, which directs the Securities and Exchange Commission to require registered credit rating agencies to rate municipal bonds on the same scale as corporate and other debt, based on the likelihood of repayment.

The committee also approved a set of revisions to a "manager's amendment" that chairman Barney Frank, D-Mass., said would allow additional distinctions between general obligation debt, which he believes is nearly as safe as Treasury bonds, and revenue bonds that are not backed by the full faith and credit of municipal issuers and therefore have some greater degree of volatility.

"The essence [of the bill] is to say that we want rating agencies to rate municipal bonds essentially by the same criteria that they rate corporate bonds, which is the likelihood of repayment," Frank said. "For revenue bonds, there are more factors."

The revisions also included a provision that restricts credit rating agencies from using "priority of repayment, recovery rate in the event of default, or expected rating volatility" as part of its assessment of the risk that an investor in a security or money market instrument will not receive repayment.

Another provision instructs the SEC to require the rating agencies to use consistent symbols for their ratings across all types of securities and money market instruments. The language, if it clears Congress, would be tantamount to a congressional rejection of a recent proposal by the SEC that encourages rating agencies to use symbols on the ratings of structured finance products to distinguish them from municipal and either types of securities.

During yesterday's markup, Frank said that municipal governments are paying for unnecessary bond insurance because their ratings are artificially low when compared with corporate bonds. He repeated an assertion made during a March hearing that buying insurance on municipal bonds is like "taking life insurance on a vampire" because the insurers are never going to have to pay.

"If munis were rated the same way as corporates, there would be no bond insurance because it would clearly never be needed," he added, paraphrasing Ajit Jain of Berkshire Hathaway Assurance Corp., who testified before the committee in March.

Committee members approved an amendment introduced by Rep. Peter Roskam, R-Ill., that calls for the Government Accountability Office to investigate if there are fundamental differences in the treatment of different classes of bonds by the rating agencies that cause some classes to suffer from "undue discrimination," and if so, why. The GAO is instructed to also consider the extent to which retail investors could be disadvantaged by a single ratings scale.

Frank and Alabama's Rep. Spencer Bachus, the ranking Republican on the committee, said the committee plans to hold hearings in September on the issue of municipal disclosure and accounting standards, and that SEC chairman Christopher Cox is scheduled to testify.

The announcement of the forthcoming hearing led at least three members to withdraw additional amendments, some of which aimed to address municipal disclosure. The hearing would come 13 months after Cox urged Congress to consider legislation to boost muni disclosure and accounting standards.

The idea of rating municipal securities in a single or global scale gained traction in the spring after California Treasurer Bill Lockyer led a campaign to push the three major credit rating agencies to rate munis on a single, global scale.

Even though Standard & Poor's and Moody's Investors Service, the two largest rating agencies, have embraced a single scale, Frank has said that legislation is needed because the agencies are not moving fast enough and could elect to reverse themselves once they make the switch.

But it was not clear if the bill will proceed through Congress. Though Frank vowed that he would like to see it voted on by the full House later this year, no one in the Senate has publicly shown any interest in the bill. Another muni bill, which would require action by the House Ways and Means Committee, seeks to loosen or extend tax-exempt bond restrictions stemming from the 1986 Tax Reform Act.

The bill, which was co-authored by Frank and Rep. Richard Neal, D-Mass, the chairman of the Ways and Means select revenue measures subcommittee, has not moved forward in the tax committee.

Though Frank and committee staff indicated that the ratings bill, as amended, would give rating agencies the ability to consider unique factors when rating municipal revenue bonds, the language appeared to say the opposite. It prohibits rating agencies from: "considering credit factors that are unique to municipal securities that are not backed by the issuer's full faith and credit in its assessment of the risk an investor in a security or money market instrument will not receive repayment in accordance with the terms of issuance."

Still, securities industry groups said yesterday that they support the bill.

"It is important that Congress continue to focus on issues affecting liquidity and stability of the municipal bond markets," Jill Hershey, a managing director of the Securities Industry and Financial Markets Association, said in a statement.

Michael Decker, co-chief executive officer of the Regional Bond Dealers Association, said the bill addresses an inherent unfairness in the ratings of municipal debt.

"If you look at the performance of municipals relative to the universe of credit products, municipals far outperform the rest of the world in terms of loss and risk of default," he said, adding that he had not yet had a chance to see the amended version of the bill.

Brendan Reilly, senior vice president of government relations at the Commercial Mortgage Securities Association, said the bill "sends a clear message that policy makers, like investors, do not support separate ratings symbols. It's a significant win for investors seeking confidence and certainty in the meaning and use of ratings."

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