The Rating Game Scam

Long time readers continue to ask why I no longer feature muni bond funds in the StatSheet and what I think about munis in general.

While we’ve owned some muni funds back in 2006/07, I no longer support them in view of the busted real estate and credit bubble. It’s no secret that states, counties, cities and municipalities suffer from severe budget deficits, which will only get worse.

Mish at Global Economics had some words to say about this topic recently. Here are some highlights:

States In Serious Trouble

In the United States, a fiscal crisis is hitting states like Arizona, Illinois, Kentucky, California, Virginia, and Illinois. California has a whopping 56% deficit as a percent of its General Fund Budget according to the Center on Budget and Policy Priorities.

California Cash Crunch

Yahoo!News is reporting California debt rating cut as cash crunch looms.

California’s main debt rating was cut on Wednesday by Standard & Poor’s, which said the government of the most populous U.S. state could nearly run out of cash in March — and another rating cut might follow.

“The big question is, is there any fear they will get downgraded out of investment grade (so) you may have to sell … that’s where I think it would get interesting or hairy,” said Eaton Vance portfolio manager Evan Rourke.

S&P;’s downgrade was overdue because the state’s revenues have been so weak, said Dick Larkin, director of credit analysis at Herbert J. Sims Co Inc in Iselin, New Jersey. “Frankly I can’t understand why it took S&P; so long,” he said. “They could have made that decision back in September.”

Larkin said the three major rating agencies will hold off on more downgrades to California’s credit rating to avoid roiling the municipal debt market, even in the event budget talks between Schwarzenegger and lawmakers drag on.

“They’ll give the state an awful lot of rope,” Larkin said. “For a state to go below investment grade would cast a pall on every state and local issuer out there.”

Rating Game Scam

There is little doubt California should be rated as junk already. Dick Larkin notes they give the states a lot of rope and wonders: “Frankly I can’t understood why it took S&P; so long.”

What takes so long is one of two things, perhaps both.

1. Sheer incompetence by Moody’s, Fitch,and the S&P;
2. The ratings model itself, encourages ridiculously optimistic ratings

The big three rating agencies get paid on the quantity of debt they rate not the quality of their ratings. The higher they rate, the more business they get. For more on the problem as well as what to do about it, please see Time To Break Up The Credit Rating Cartel.

The big three did not downgrade Enron until after it blew up, and held of on downgrades of GM, Ambac, MBIA and others with share prices hovering just above zero.

Until the model changes, we will continue to see this kind of corruption and incompetence, for the simple reason the model is designed to reward corruption and incompetence.

Thus, California will not get downgraded to junk no matter what California does, short of default. None of the big three will risk roiling the municipal debt market because it would hurt their own profits to do so.

California is not the only state in serious fiscal trouble, although maybe one of the worst ones. In my view, the odds are increasing every day that some debt will have to be defaulted on or will at least get another downgrade as time goes on, despite the rating scam as discussed in the article.

None of this will bode well for muni bond holders and personally, I just as soon not take the chance of having any exposure in that area.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
This entry was posted in Uncategorized. Bookmark the permalink.