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California's Lockyer Eyes Forming a New Insurer

Despite his recent criticisms, Bill Lockyer understands the value of bond insurance.

The California treasurer is considering a proposal to bring together the state's largest pension funds to form a monoline bond insurer. The idea, currently in the exploratory stage, could also include Lockyer reaching out to pension funds in other states as well for participation.

There is some precedent for such a system. The California State Teachers' Retirement System already provides enhancement on some credits, and has been doing so since 1994. And a commentary in The Bond Buyer earlier this month proposed just such a solution.

This is the latest plan put forth by Lockyer to address the municipal rating scale and the current system of credit enhancement that he believes discriminates against taxpayers and municipal issuers. As treasurer, Lockyer serves on the boards of both California Public Employees Retirement Fund and CalSTRS, two of the largest public pension funds in the country.

"We don't have a problem with people making money," said state spokesman Tom Dresslar. "What we have a problem with is taxpayers getting ripped off, and that is what is happening under the current system."

In recent weeks, Lockyer has been outspoken against the current system, in which the rating agencies assign less-than-perfect ratings to municipal bond issuers, who then often turned to bond insurers to buy enhancement to bring their credit rating to triple-A levels.

Numerous recent downgrades of the financial guarantors - policies purchased from which are used to raise ratings - have led a segment of market participants to clamor for a rating scale that more accurately portrays the low default rates of municipal bonds.

Since Lockyer circulated a letter questioning municipal ratings, a dozen other state treasurers, some issuers, CalPERS, and members of Congress have all asked the rating agencies to look into changing the municipal scale.

Supporters of a unified scale believe that the current ratings cost municipalities millions of dollars in increased borrowing costs by rating issuers lower than they should be, once municipal default rates are taken into account. In addition, a single scale would allow investors to better assess the risks of the municipal market and price the bonds accordingly. Largely, Lockyer has questioned the rating levels on full faith and credit general obligation debt.

The debate over ratings comes as hundreds of auctions and variable-rate debt remarketings failed over the last month, contributing to rising debt service costs for issuers. Last week both Moody's Investors Service and Fitch Ratings announced plans to consider the adoption of a single scale, with Moody's releasing a request for comment on their plan to assign a global rating to any issuer that wants one, set to begin in May. Moody's is accepting comments until April 15

Standard & Poor's, however, continues to maintain that it uses a single rating scale across all sectors, a notion that Dresslar and other market participants dispute. Dresslar said the agency uses a higher standard to rate munis than they do corporates.

"Standard & Poor's, in contrast to its competitors, has done nothing but issue condescending letters, stonewall, and misstate the facts," Dresslar said. "California is not a serf in the kingdom of Standard & Poor's."

In fact, Lockyer is considering using the state's pension funds to launch a proxy battle against Standard & Poor's parent, McGraw-Hill Cos., to push for changes in how the rating agency assigns ratings to municipal bonds. Between the two funds, CalPERS and CalSTRS, own 0.56% of McGraw Hill stock, or about 1.8 million shares.

When asked for comment, Standard & Poor's spokesman David Wargin referred to a statement previously released by Standard & Poor's.

"We believe it is important to have one global rating scale that is widely understood, which is why we use the same scale across all sectors," the statement said.

Also yesterday, California released the text of a note from Lockyer to all underwriters and financial advisers with which the state does business, in which Lockyer asked them to consider making their own voices heard on the rating issue. In the note, Lockyer said he would respond in favor of the Moody's policy, with three caveats.

First, Lockyer said he hopes this is the first step toward a single rating scale determined on a global basis. Second, he said he would ask Moody's to find a way to make the global rating scale applicable for the Securities and Exchange Commission's 2a-7 rule, which says that securities must be rated at least double-A to be eligible investments for money market funds. And third, he will ask Moody's to assign a global rating free of charge, as opposed to the current policy of charging one basis point of par for a municipal issuer to have a global scale rating in addition to a municipal rating.

The California treasurer is also considering whether the state will do business with Berkshire Hathaway Assurance Corp., the new bond insurer started late last year by Warren Buffett. According to Dresslar, Lockyer found the congressional testimony provided by Ajit Jain this month to be self-serving. Dresslar said Lockyer has told Buffett that unless he distances himself from Jain's remarks, the state will not do business with Berkshire Hathaway.

Jain, the head of BHAC, did not return a call for comment.

Proponents of a global or unified rating scale have been gaining ground lately. A one-question online poll conducted by The Bond Buyer found that of 183 respondents, 61%, or 111 votes, were in favor of a unified scale, while 39%, or 72 votes, were against it.

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