Until recently, politicians like Weld seemed to have the power, while analysts like Tillman labored in obscurity, crunching the numbers of states, towns and sewer authorities and rating the risk of bonds they offered for sale to investors. Traditionally, their ratings of corporate debt have drawn more attention. But the spotlight on “muni” ratings is now a laser. For one thing, there’s more of this kind of debt out there (about $1 trillion). And the issues are incendiary: a state’s rating can put pressure on its budget, leading to fiery public debates over such things as raising the sales tax or cutting teachers’ salaries. Then there’s politics. A good rating may win points for a governor; a bad rating can hurt at the polls. So when things get dicey, political officials and their finance chiefs spend endless hours phoning, faxing and courting the agencies. When Governor Weld was elected in 1990, he paid a visit to S&P even before being sworn in.
It’s no wonder that an unkind word from an agency can inspire municipal malice. When S&P removed California’s long-standing pristine rating of AAA in December 1991, state Treasurer Kathleen Brown compared S&P to “the Grinch that stole Christmas.” With New York City’s ratings under review last year, Mayor David Dinkins vowed rebelliously to answer to a higher authority than rating agencies: “Our people … whose voices are too small.” And in an unusually tense confrontation last summer, Detroit’s public officials attacked Moody’s for demoting the city to junk-bond status and questioned whether the agency’s decision involved bias against largely minority cities.
Ratings are the big-time version of the humble consumer’s personal credit rating. And hearing that you just don’t cut it anymore isn’t pleasant, whether you’re trying to buy that new coupe or trying to keep hospitals open. A lower rating isn’t just a slap in the face of civic pride. It means that investors won’t be so thrilled about the bonds you’re trying to sell. Less enthusiasm means fewer takers, and that means it’s more expensive to borrow money. And more expensive money brings out the budget slashers: firefighters get fired, libraries close and tolls go up.
Agencies such as S&P and Moody’s argue that their power is exaggerated. They are more like beleaguered umpires than powerful wizards, says Leo C. O’Neill, president of S&P’s ratings group, and the umpires “get confused with the players.” At first glance, ratings do seem an unlikely source of drama. A team of public-finance wonks and M.B.A.s closet themselves with debt schedules and engineering reports in cubicles in lower Manhattan (where the big two, S&P and Moody’s, and Fitch Investors Service, a distant third, make their home). The analysts fly in and out of Detroit, say, and spend hours debating industrial job growth. Finally they put out an eye-glazing report (30 to 40 of these a week, in fact, at Moody’s), saying something like: “Detroit is no longer Baa. Now it’s Ba1.” Then all hell breaks loose.
For years, any excitement about munis was rare. Cities and states issued bonds routinely and paid agencies to rate them. There were few surprises, and munis were long considered among the safest investments. Most still are. But financial crises in Cleveland and New York in the 1970s and the default of the Washington Public Power Supply System (nicknamed WHOOPS) in 1983 did a lot to eliminate peace of mind. So did the city of Bridgeport, Conn., when it tried to declare bankruptcy in 1991; a court later declined the petition. Paying the public bills has also gotten tougher. Since tax revolts began in the late 1970s, governments have less tax money available. And since Ronald Reagan’s “new federalism” mandated that states pick up expensive spending programs, obligations have grown while expensive social problems have swelled.
Munis are cheaper for states and cities than bank loans, and because they’re tax-free and usually reliable, investors gobble them up. The amount of debt issued by municipalities has increased sevenfold since 1970, to $272.7 billion last year. Big investors, like pension funds, hold munis. But most of that debt is bought by individuals on their own or through mutual funds. And while big investors have their own analysts to help them invest, individuals count on the rating agencies. If the debt gets downgraded, it could mean that their nest egg is at risk. “Clearly we have impact on market prices,” says Daniel N. Heimowitz, director of public finance at Moody’s. And the impact may only grow as new investors start looking at munis as a way to find relief from Clinton tax hikes.
For politicians, a bad rating can offer a chance to blame someone else for problems or serve as a useful public-relations lever. The mayor of Melrose, Mass., got voters to approve new taxes last year, but only after Moody’s put Melrose on junk-bond status. Still, every case is painful, and Detroit has had a particularly bad time. The city has struggled financially for years, suffering from the auto-industry decline and a litany of urban woes. Last July Moody’s dropped Detroit’s rating below investment grade and asked whether the city could be “viable” over the long run. Detroit is using dangerous short-term fixes for the budget, Moody’s argued, some of its long-term strategy was “suspect” and political barriers were still big. Moody’s had warned the city that its rating was in jeopardy, but the city thought it was making progress.
Mayor Coleman Young and other officials were furious, charging that the agency was suddenly applying new standards, suggesting that Moody’s was simply writing off urban America and observing that Moody’s had no minorities on its Detroit team. It didn’t help Moody’s when, at just the same time, employees filed a complaint with the EEOC charging Moody’s with discriminatory employment practices. (Moody’s says that the complaint has no merit.) Detroit finance chief Bella Marshall says the media exaggerated the conflict and adds that “I’m not going to brawl” with the rating agencies. Heimowitz, who heads Moody’s team, says the firm stands by its rating.
That conflict and others have kicked off a new round of debate in the industry over what’s known as the quality-of-life problem. The crucial question: what factors should affect a rating? Of course an agency looks at a municipality’s real-estate values, job base and infrastructure (chart). The rub comes with the “social issues,” such as crack babies or the homeless. Even Moody’s and S&P can’t agree. “To ignore these factors would be shortsighted,” says an S&P report, although it says they aren’t “primary.” But Paul Devine, a Moody’s vice president, says that simply “seeing lots of homeless [on the street] does not have any relevance. A [court] mandate to house the homeless? Yes.” This leaves plenty of room for confusion. After all, Moody’s downgraded Detroit; S&P hasn’t. And critics say that the agencies, even with added staff, urban experts and other specialists, aren’t equipped to evaluate such issues.
Some of the din over ratings could soften in coming years if the recovery proves solid and the Clinton administration lifts the states’ burdens. But the nasty business of financing public life will continue for years, keeping raters in the spotlight. They may be lowly umpires, as they insist, but expect to keep hearing loud disputes over many more of their calls.
How secure is a city’s debt? That’s the question agencies try to answer when they rate a bond. To reach a verdict, they look at everything from pollution controls to the political clout of the mayor. Some big factors:
How much debt is on the books, and how does it compare with the value of homes and businesses that can be taxed?
Are all the bridges falling down? Are the streets filled with potholes? More important, has the city budgeted enough to fix them?
How many well-paying jobs are there? Are they secure or could they end up being exported to Mexico? If jobs decline, so does the tax base.
Is there any big-money litigation going on? lt a judge rules that a state must build more prison cells, how are lawmakers going to pay for it?
Could a city or state impose more taxes it had troubles paying its bills? Or does it look like the voters or legislators would refuse to go along?
Who lives in the area? Are there enough people paying taxes to balance out retirees or those on welfare?
