Beware of credit rating agencies and a municipal bond bubble

In 1790 James Madison wrote that “a public debt is a public curse.” This is a particularly valid statement to consider since Texans live in a state with some of the highest government debt loads in the nation. Texas as a state ranks 10th in the nation with per capita debt, 2nd in the nation with per capita debt for local governing entities, and when all debt is calculated, Texas ranks 5th in the nation for debt per capita behind only California, Illinois, Pennsylvania, and New York. Yet credit ratings continue to stay high for these government entities despite their inability to control spending. Perhaps it’s time to consider the source of the credit ratings.

Local municipalities and school districts will tout their credit rating when trying to convince the public that a bond should pass. The thought of bond supporters is that if the government entity seeking passage of the bond has a high rating, then they are fiscally responsible and therefore voters should trust them to pile on the debt. The implicit message to the voters is: If rating agencies trust us so should you. What we should not forget is that bond rating agencies gave AAA ratings to toxic investment tools prior to 2008 which precipitated the market crash.

It was not that long ago that rating agencies were considered at least partly responsible for the financial collapse in 2008. Rating agencies would be asked to rate a complex security so that those firms that put the security together and were trying to sell it could attract more customers. Firms who were shopping collateralized debt obligations (CDO) and mortgage backed securities (MBS) to unwitting customers could point out to the potential mark that an independent rating agency had given their full throated support of the MBS or CDO. A high credit rating would give the potential buyer confidence that they would see a good return on their investment and therefore would make them more likely to invest. Unfortunately credit rating agencies were not that reliable and their ratings proved almost meaningless. Many of the AAA rated securities crumbled and billions of dollars were lost.

Remarkably those same credit rating agencies are still in business handing out their opinions on government issued bonds. This year Texans will go to the polls and vote on whether to approve a bond. Several ISDs including Tyler, Palo Pinto, Whitesboro, Bushland, Sabine, Austin, Clear Creek, and the Lone Star College System all have bond issues before voters on the May 11th ballot. Each of these districts have their own reasons for needing money and each has different arguments for and against the bond proposals. What I would urge voters to do is research the issue themselves and not rely on bond rating agencies. When we as voters turn our responsibilities over to other entities we can be taken advantage of.

Stockton, CA, Harrisburg, PA, and Jefferson County, AL all had AAA ratings until they went bankrupt. Sometimes warning signs are present and sometimes they are not. The best way voters can make sure they are not being misled is to use a little common sense and see if the debt they are being asked to approve seems excessive regardless of what a credit rating agency says.

The words of Thomas Jefferson make some sense in this case, however. Jefferson wrote to John Taylor in 1816, “And I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity in the name of funding, is but swindling futurity on a large scale.”