By DAVID MOON, Moon Capital Management,
LLC June 22, 2008
They're at
it again in Washington.
Chairman Barney Frank (D-Mass.) of the House Financial
Services Committee said last week that he might propose legislation mandating
the type of evaluation processes to be used by bond-rating agencies. He argued
that it was unfair that companies like Moody's, Standard & Poor's and Fitch
don't necessarily use the same metrics for municipal bonds when applying credit
ratings as they do for corporate or even federal government
debt.
Frank says that if the same methods were used on
municipal bonds, cities and states would receive higher credit ratings, implying
a lower risk of default. This would, presumably, lower the borrowing costs for
these states and cities.
Have they run out of things to do in Washington? Can't they
have some baseball hearings or sex scandals? Either would make more sense and be
more productive.
Bond ratings are produced by private companies. If the
federal government wants to get into that business, it shouldn't tell private
businesses what to do. Instead, Representative Frank and his buddies could build
a huge new marble building in Washington, hire a few thousand bureaucrats
and produce whatever type of ratings they want. Heck, they could even produce
ratings on stocks and mutual funds. On slow days, they might start an NFL
betting line.
But they have no business telling Moody's how to do its
job.
The crux of Frank's position is that an investor can't
easily compare the creditworthiness of a corporate bond and a municipal bond
each possessing the same credit rating. Municipal bonds have been much less
likely to default than corporate bonds, yet the ratings don't suggest
that.
But the ratings are not meant to measure risk across
asset classes. What they do purport to assess is the relative risk of two bonds
within the same asset class. An A-rated municipal bond is considered less risky,
all else being equal, than a B-rated municipal
bond.
Congressman Frank's position is that if the ratings
reflected the relative safeness of the municipal bonds vis-'-vis corporate and
federal government bonds, munis would generally have higher ratings than they
now do.
There is, of course, another possibility. The bond-rating
agencies could simply downgrade all the other bonds, including those of the
federal government.
That's right.
If Washington politicians are so concerned about
properly evaluating the balance sheets of debt issuers, they could start by
evaluating the balance sheet they run.
From a strict asset-liability standpoint, most states are
more solvent than the federal government. Forty-four governors ' who, unlike the
feds, can't just print more money ' are required to submit balanced budgets to
their legislatures. Managing a fiscally sound state is apparently easier than an
entire country.
If Barney Frank wants the bond-rating agencies to more
accurately reflect the relative creditworthiness of different types of bonds,
he'd better be careful what he wishes for.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).
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