WASHINGTON — House Financial Services Committee chairman Barney Frank
Stressing that defaults on general obligation debt issued by states and localities are practically non-existent, the Massachusetts' Democrat said the use of separate scales for municipal bonds has caused high-quality municipal bonds to be rated lower than corporate debt with a similar or higher risk of default.
To emphasize his case that munis are ultra safe, Frank pointed to the District of Columbia, which was rated below investment grade by one rating agency in the mid-1990s. Even so, Frank said he would have happily purchased low-rated bonds issued by the nation's capital, which has since returned to financial stability.
"It's not whether you like Marion Barry that decides whether or not they're going to pay the bonds," Frank said, referring to the district's four-term mayor who presided over the city during its financial crisis. "It's the fact that the taxing power is there. If I had known that Washington, D.C., had junk bonds 10 years ago, I would have bought them, because I'd be much richer today than I am. I'd be rich."
And in a nod to market participants who support a single scale but want to maintain some degree of gradations among different municipal credits, Frank's ratings bill would prohibit the Securities and Exchange Commission from barring rating agencies from providing additional "complementary" ratings to measure a security's volatility or risk.
The bill also instructs the Treasury secretary to collect information on the municipal bond insurance industry and require that the Treasury Department annually report to Congress on the matter.
Treasury spokeswoman Jennifer Zuccarelli said the department is reviewing the legislation while SEC spokesman Kevin Callahan declined to comment on the bill but said, "We share the chairman's interest in meaningful ratings."
Frank said that his committee would vote on the credit rating bill on Tuesday. It was co-sponsored by Rep. Michael Capuano, D-Mass., and Rep. Paul Kanjorski, D-Pa., who is the chairman of the subcommittee on capital markets.
The second bill, which would require action by the House Ways and Means Committee, seeks to loosen restrictions on tax-exempt bond ownership stemming from the 1986 Tax Reform Act that decreased the amount of tax-exempt income that banks and corporations could own. He said the restrictions had unintended adverse consequences on governments and nonprofit issuers.
The tax bill, which is co-authored by Rep. Richard Neal, D-Mass., the chairman of the Ways and Means select revenue measures subcommittee, would increase the tax code's so-called bank deductibility limits, which currently allow banks to deduct 80% of the costs of purchasing and carrying tax-exempt bonds issued by states and localities where annual bond issuance does not exceed $10 million. If enacted, the bill would raise that cap to $30 million and peg it to inflation going forward.
Another measure in the bill seeks to increase private sector incentives for purchasing tax-exempt bonds by expanding the 2% de minimis rule to enable more types of corporate investors to benefit from owning them. The rule's name derives from it allowing corporations to deduct the cost of interest on their tax-exempt debt, without having to prove that they did not borrow to buy the bonds, as long as tax-exempt bonds are 2% or less of total assets.
Under the bill, the de minimis rule would be expanded to apply to financial institutions like banks and securities firms, a move intended to eliminate certain disincentives for such firms to purchase tax-exempt bonds.
Michael Decker, co-chief executive officer of the Regional Bond Dealers Association, praised the bill and said it would "spur demand for municipal securities, enhance liquidity, and keep rates low for issuers."
Representatives of issuer groups also praised the legislation. Frank Hoadley, the chairman of the Government Finance Officers Association's committee on governmental debt, said the bill regarding rating scales satisfies the desires of those who want a separate scale based on the ability to pay alone, while also allowing for a complementary rating that will provide gradations some investors want to distinguish between different municipal credits.
Frank said at a press conference Friday that there is no version of either bill in the Senate and Congressional sources have indicated that it is likely too late in the congressional calendar to expect either bill to make it through both houses. But Neal predicted it would become a priority next year if Congress fails to act this year.
Frank also dismissed concerns that the credit rating agency bill would raise First Amendment concerns or that Congress was overstepping. "We're not telling you what the rating should be, we're telling you what the criteria should be," he said.
By mandating that municipal securities are rated on the same scale as other securities, Frank said he was following up on a threat he made in March in which he urged credit rating agencies to abandon their dual scales voluntarily or else face this kind of legislation mandating the change.
Even though Standard & Poor's and Moody's Investors Service, the two largest rating agencies, have embraced rating municipal debt on a single scale, Frank said that legislation is still needed because the agencies are not moving fast enough and could elect to reverse themselves once they made the switch.
Standard & Poor's has said that it already has a global scale which is used across all sectors. Still, spokesman Chris Atkins said Frank's approach could "too easily result in an erosion of ratings independence, with the ultimate perverse effect of creating a system in which muni ratings would be determined not by objective analysis but by governmental mandate or the threat of litigation from municipalities or states that believe their ratings are too low."
Tony Mirenda, a spokesman at Moody's, said that the rating agency "remains committed to taking steps that appropriately address the changing dynamics in the global capital markets."
Two weeks ago, Moody's altered its plan of offering both municipal and global scale ratings for municipal bonds and instead proposed migrating its municipal scale so that it is in line with its other global ratings.
A spokesman for Fitch Ratings, the third largest rating agency and the only one that has not yet voluntarily moved in the direction of a global scale, said that Frank's legislation is a "constructive step in progressing the issue."
