California’s credit rating enjoys a dubious distinction: The rating, the benchmark that determines how much the state is charged to borrow money, is the lowest of the states except for Louisiana – which is tied for last place. A rating of AAA is the highest and California has A1. The last time California had an AAA rating was in the 1980s.
The state’s credit rating is critical, especially as the Wall Street turmoil thus far is freezing credit and the state faces the likelihood of ever-higher interest rates. But the problem is that the interest rate is not tied to risk, says state Treasurer Bill Lockyer, who supervises the state’s borrowing. He notes that nobody has ever lost money buying the state’s general obligation bonds – bonds approved by voters and backed by the General Fund – but the rating doesn’t reflect that assurance. Wall Street rates public and corporate entities differently, even though they may have similar track records.
Because of the low rating, California is required to buy insurance from a triple-A carrier, which pushes up the cost to the state. His office estimates that a revised credit rating could save the state hundreds of millions of dollars annually. California by far is the biggest borrower in the nation’s municipal bond market, with about $51 billion in outstanding bond debt. The U.S. entire municipal market totals about $2.6 trillion.
So since March, Lockyer, a Democrat, has led a national effort to change the rating system. Thus far, the plan has drawn mixed reviews. But he has allies across the country, in New Jersey, Wisconsin and Connecticut, and elsewhere.
In Connecticut, state Attorney General Richard Blumethal has sued three Wall Street bond-rating agencies – Moody’s, Fitch and Standard & Poor’s corporate parent The McGraw Hill Companies. Blumenthal’s suit, filed in July, contends that the rating agencies unfairly gave municipal bonds lower rates than similar corporate or structured debt. In Los Angeles a few days later, City Attorney Rocky Delgadillo filed civil suits against more than two-dozen Wall Street firms, including JP Morgan Chase, Citigroup, and Morgan Stanley, among others. Because of the interest rates, the city of Los Angeles did not obtain competitive rates for investing its bond proceeds, and lost tens of millions of dollars it should have earned, Delgadillo said at the time.
California’s position is similar: If a revamped credit-rating system had been in place in March, the state estimates it could have enjoyed major savings, perhaps as much as $5 billion.
“We’re talking about hundreds of millions of dollars in taxpayers’ money that they shouldn’t have to be paying,” said Lockyer spokesman Tom Dresslar.
“The promise that a bond issuer makes to the investor is, ‘We will pay you your money on time and in full,’” Dresslar said, “and the state of California has never defaulted.” He noted that the payments to the bond buyers are protected by law in the constitution, second only to payments to schools. “We deserve the right to be triple-A on the natural,” he added.
Wall Street remains skeptical. In an interview with Bloomberg News, Moody’s chief executive officer Raymond McDaniel, referring to the Blumenthal suit, said the credit-rating allegations were “meritless,” and that the suit “implies that the rating system is wrong.”
“That’s like saying it’s wrong to measure distance in centimeters and right to measure it in inches,” he added.
Fitch, in a special report filed by its Public Finance unit on July 31, said it reviewed the issue over a four-month period, and said that a “recalibration would result in upward revisions.” No final decisions have been made, however.
But Fitch also was cautious about revising credit ratings until “the impact of the current (economic) downturn is clear.” That was written at the end of July. Since then, the financial turmoil on Wall Street has deteriorated dramatically, which may delay any move to recalculate municipal, general obligation bond ratings.
Meanwhile in Congress, Rep. Barney Frank, a Massachusetts Democrat and chairman of the 70-member House Financial Services Committee, has introduced HR 6308, which establish uniform credit ratings for municipal bonds. The measure has emerged from committee and is expected to come up next year.
Assemblyman Pedro Nava, D-Santa Barbara, the chair of the Assembly Banking and Finance Committee, agrees with Lockyer. He believes the methodology for corporate credit ratings should be far more stringent.
“If there are any entities that deserve a higher premium based on risk, it would be the numerous privately held corporations that have done all manner of fiscal shenanigans, outrageous executive compensation packages and golden parachutes. Those corporations should be paying more,” said Nava, whose committee has scheduled a hearing this week into the impact of Wall Street’s woes on California.
Currently, California is rated A+ by Fitch, and Standard & Poor’s and A1 by Moody’s; the A+ ranking is equivalent to the A1 designation. The last time California received an AAA rating from Fitch and Standard & Poor’s was in July 1986, and the most recent AAA rating from Moody’s Investors Service was in October 1989.
According to the state treasurer’s office, the lowest rankings for California’s credit rating occurred in 2003. In July 2003, Standard & Poor’s dropped the rating to BBB, and five months later, the other two agencies did likewise. According to Wall Street experts, only bonds rated BBB or better are suitable for institutional investing. The state’s bond rating dropped that year amidst a budget crisis, economic fears and a political battle that ultimately resulted in the recall of Gov. Gray Davis that fall.
In California, the dispute over credit ratings is more than a numbers’ game. Movement up or down the scale translates directly into dollars.
“To the extent that we pay higher borrowing costs that are unwarranted, it does affect the state budget. Those are dollars that we don’t have to fund schools,” Dresslar said.