The idea that municipalities should be rated "the same way" as corporations is not entirely valid. Credit-wise, they are very different types of borrowers, and the credit issues are very different. In the area of municipal credits, much of the credit strength is derived from: a.) the historical and the prospective integrity and balance of the municipal budget; b.) the relevant property tax base; and c.) the moral strength and actual commitment of the municipality's promise to pay.
The problem is, if a municipality wants to file an abusive bankruptcy, it is much easier for them to do that and get away with it (once, maybe - after that, investors won't want to lend them low-cost money) than for a corporation, in part because most municipal bonds include no specific pledge of collateral per se, either by way of a mortgage or general corporate assets.
In contrast, most corporate bonds do have collateral, and that collateral is much more available to creditors in a bankruptcy situation than is the case with creditors of a municipality. It seems clear that some municipalities in America are having serious credit problems, and it is also clear that the appropriate answer to that is not positioning the municipalities to become abusive borrowers and-or fraudulent or sharp-elbowed bankrupts.
By virtue of the current credit problems facing America's municipalities, investors are significantly more leery of muni bonds than before. That is a very serious problem, and one that will not go away overnight.
In particular, the recent attempt to rubber-stamp Securities and Exchange Commission approval for the sleight-of-hand technique of municipalities bidding at their own bond auctions portends ill for the municipal marketplace.
At the end of the day, if when credit trouble arises municipalities circle the wagons and arm up their lawyers, rather than dealing with the credit issues honestly, people are not going to buy muni bonds anymore.
The next step after that is they will have to borrow from the federal government - and their interest costs will probably double or triple.
Let's hope it does not come to that.
If municipalities are underrated credit-wise, that is a problem; however, the premise that they should be rated "the same way" as corporations is in fact false because it is not possible. And today, municipalities are getting more aggressive in their financial tactics, not less - and the rating system(s) are primarily there to protect investors.
Matt Lechner, CFP, CRPS, CIMA, FRM, is chairman of the Wall Street Special Interest Group