Local governments spend a lot of time (and some money) trying to - TopicsExpress



          

Local governments spend a lot of time (and some money) trying to get a better bond rating. Obviously theres an immediate reduction in borrowing costs that accompany the improved bond rating. But does this improved rating help or hinder during bad times? The Spring 2014 issue of Public Budgeting and Finance had an article by Jun Peng, Ken Kriz, and Qiushi Wang that looked at that question. Basically, they compared municipal bond yields for various ratings to corporate bonds with the same rating. During normal times (before the Lehman Brothers bankruptcy), municipal bond yields of both high and low quality tracked the corporate bond yield in a similar fashion. But when the shit hit the fan, there was a significant difference between the high and low ranked populations, with the yields of the low ranked bonds climbing much higher in comparison to equivalent corporate bonds than high ranked bonds. This implies that the market feels that low ranked municipal bonds were riskier than equivalent corporate bonds. This significantly increases the cost of borrowing for municipalities with poor ratings. In fact, after the bankruptcy, the amount of debt issued by those municipalities also dropped significantly. The article had two policy recommendations. First, maintain the best rating you can. Second, bond insurance is probably far more important for poorly ranked municipalities. (There were other recommendations in the article. ) My only concern with the study had to do with the populations they chose. The study relied upon summarized investment data, segregated by rating. This means that a bond rated AA before the meltdown and BBB after would be in two separate categories, making the study less reliable in terms of tracking the behavior of the same bonds over time. How important this issue is depends upon the number of rating changes over the term of the study. If only a few bonds were reranked, then it would just be a little noise. But if a lot were changed due to a closer examination of the bonds due to heightened concerns, then the study many have a serious methodological concern.
Posted on: Fri, 28 Mar 2014 16:58:51 +0000

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