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The Haas Institute Releases a Report on the Costs of Harshly Rating Municipal Bonds

A new research report examines the way municipal credit ratings are unnecessarily harsh relative to other asset classes & measures how much this has cost cities

April 2017, Berkeley, CA: The Haas Institute for a Fair and Inclusive Society released a new research report on the implications of unnecessarily harsh credit ratings for municipal bonds. Entitled “Doubly Bound: The Cost of Harsh Municipal Credit Ratings,” the report argues that municipalities are assigned credit ratings that are more stringent than other asset classes’ assigned credit ratings. The report also uses an alternative model to measure credit ratings that demonstrates a more accurate measure of risk given past performance. This model is used to measure the additional costs to municipalities of the lower credit ratings assigned by credit rating agencies.

"This analysis is not only a technical exercise, these credit ratings have enormous impact on local government finances," says Wendy Ake of the Institute's Just Public Finance program. A lower credit rating, even one that is associated with only small changes to the interest rate creates annual debt service fees that can significantly increase local expenses. The additional costs to cities alone is measured to be $2 billion annually.

An example at the state level: Connecticut’s rate, or its cost of borrowing, was 2.53 percent. This is 0.5 percent higher than states with the lowest borrowing costs at the time. This 0.5 percent difference would increase the cost of borrowing by $2.5 million per year if the bond sale were to generate $500 million.

“When cities are experiencing escalating crises with expenses that exceed local revenue, any unnecessary costs have to be examined and their causes have to be addressed,” says Ake. “In this case, we learn that credit rating agencies provide inaccurate measures of risk. We already know this from their role in the 2008 financial crisis. Now we have another reminder.”

When cities are rated with these lower credit ratings it increases a city’s financial burden by adding additional expenses. In many cases, these expenses increase when municipal revenue is decreasing. “Credit rating agencies played a big role in the housing crisis and now they continue to harm the finance of cities that have been financially drained by the housing crisis,” noted Ake.

The study makes a first effort in considering other methods to assign credit ratings. “There is growing interest in new ways to assign credit ratings. This paper represents one of them. We need to develop thinking on better measures,” says Ake.

Download the report here.

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Wendy Ake
Just Public Finance Program
Haas Institute for a Fair and Inclusive Society
Tel: 510-642-3326

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The Haas Institute for a Fair and Inclusive Society at UC Berkeley is a research institute bringing together scholars, community stakeholders, policymakers, and communicators to identify and challenge the barriers to an inclusive, just, and sustainable society in order to create transformative change.

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