Now Is Not the Time to Slacken Credit Standards

Briefly in reply to California Treasure Bill Lockyer's letter published in The Bond Buyer on March 24, the credit issue is not exactly as Mr. Lockyer suggests. At this time in history, the municipal credit marketplace is under what can reasonably be described as moderate stress. Unfortunately that can mean higher borrowing costs - particularly for those borrowers with moderate to weak credit.

The answer is not to throw up a smokescreen and slacken the credit standards in a melee. Actually, that will not drive down borrowing costs either because the credit facts will be the same. It's like trying to say you caught a bigger fish by changing the yardstick, and that does not work. The fish does not get bigger.

The premise for retinkering the rating systems, as presented by Mr. Lockyer, and his associates, is not accurate. The credit rating agencies are not out to get him. Not today, not a year ago, and not five years ago, or ever. They simply deal with the reality of the credits they analyze. The risk profiles of municipals and corporates are in fact somewhat different - which is why they have been treated slightly differently over the years. And the net of the marketplace action over the years has been extremely low borrowing costs to municipalities, which has been very beneficial to them and it is important not to inadvertently ruin that.

Today, in a market environment that is very dynamic and credit-wise somewhat uncertain, with certain municipal (and corporate) issuers trying to really push the envelope with curious if not unethical practices like self-bidding, and some bizarre and costly derivatives activity on the investment side - it is not right for the rating agencies to get strong-armed into slacker standards. That's not right. In fact, it's wrong and self-defeating looking out into the longer term.

The problem is, when you get aggressive finance going and the credit scenario gets tested, either the assumptions hold up or they don't. The issue that really holds its ground and affirms the basic approach of the rating agencies is that the collateral backing municipal bonds is not comparable to the collateral that backs corporates.

That does not mean it is bad collateral - it is just different. The bond investors really do not look to the potential of seizing town halls and water plants as security for bond investments. Municipal bonds rely much more heavily on the municipality's promise to pay - that is an inescapable fact. And it is based in part on trust.

It affirms the reality, which is really a matter of objective analysis, that the two categories of bonds under discussion, i.e. muni's and corporates, have some very meaningful structural differences. That does not mean munis should be penalized, and in fact they are not. The historically very low rates across the board clearly attest to that. And the rating agencies helped to achieve that.

A lingering concern in the background is that the issue that is being argued over is not the real issue. Budgets are bloated and tax revenues are lightening up a bit across the board, and some sharp practices have been exposed and objected to in the marketplace. That is a little bit of a crunch scenario. Blaming that on the credit rating agencies is not valid. Particularly when there is a market crunch going on, be it modest or significant, it is vital that the ratings systems maintain their autonomy.

Matt Lechner, CFP, CRPS, CIMA, FRM; chairman, Wall Street Special Interest Group

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