Municipal Ratings: S&P and Moody's Diverge

 |  Includes: MCO, MLN, MUB, SMB, SPGI, TFI
by: Felix Salmon

The NYT did a very good job of moving the municipal bond ratings story forwards yesterday - and making it the newspaper's lead story, no less. One thing it does is answer my question for John Carney and provide the name of a municipal bond investor who defends the current system. But much more importantly, the story opens up a huge gulf between Moody's (NYSE:MCO), on the one hand, and S&P, on the other.

The investor, first:

"If you rate 95 percent of the issues the same, the ratings cease to be useful, and investors need and utilize these ratings to differentiate credits," said John Miller, chief investment officer at Nuveen Asset Management in Chicago, which manages about $65 billion in mostly tax-exempt bonds.

I don't buy this argument at all. Firstly, no one is suggesting that 95% of municipal bonds should be AAA-rated. Maybe two-thirds. More to the point, it's the present system which gives everything the same AAA rating, by forcing municipalities to buy monoline wraps. If you want a system where 95% of the bonds have a AAA rating, just keep the status quo.

As for differentiating credits, I still don't see why tiny differences which would be comfortably absorbed within the AAA range were they in the corporate arena suddenly become hugely important when they're in the municipal arena.

But the part of the article which jumped out at me was this, from S&P:

Executives at S.& P., however, say they use a single global rating scale to measure all kinds of debt. Colleen Woodell, chief quality officer for public finance, acknowledged that municipal debt had defaulted at lower rates than corporate issues, but she noted that the data covered a relatively benign 20-year period.

A single global rating scale. This only goes to prove that either S&P or Moody's is rating municipal bonds incorrectly:

Gail Sussman, the Moody's executive in charge of public finance ratings, likened the firm's dual ratings scale to a ruler that measures in inches on one side and centimeters on the other.

S&P and Moody's generally rate municipalities identically. Since S&P uses a single rating scale and Moody's uses two different scales, there's a massive discrepancy here. And Gail Sussman doesn't help her cause much at the end of the article:

Ms. Sussman, of Moody's, said the firm would be wary about adding qualifiers to triple-A ratings, which the company regards as "gilt-edged."

If triple-A ratings are really "gilt-edged", then Moody's shouldn't be giving them out willy-nilly to corporate and structured bonds. The damage to AAA's gilt-edged reputation has already been done, as any holder of AAA-rated subprime bonds will tell you.

It would be consistent - and honest - for Moody's to refuse to upgrade municipal bonds on the grounds that it had made some big mistakes on the corporate and structured bond front for many years, and that it didn't want to further sully AAA's reputation. But its actual position just comes across as slippery.