State aims to revamp ratings on munis

California wants to change how securities in the $2.6-trillion municipal-bond market are rated, arguing that credit-grading firms exaggerate the risk that cities and states will default on their debts.

“It’s unfair to issuers,” said Paul Rosenstiel, debt manager for California. “It’s unfair to taxpayers who then pay higher interest rates.”

Many public borrowers, and every state except Louisiana, would have a triple-A rating if measured by the same scale used for companies. Getting that rating could reduce the need for insurance that backs about half of all state and local government debt.

The value of that insurance has been called into question in recent months as the guarantors’ own ratings have been threatened by their exposure to sub-prime mortgage bonds, prompting investors to shun insured bonds and driving up municipal borrowing costs.

In a letter, California Treasurer Bill Lockyer is calling on the ratings firms to treat municipal debt the same as corporate debt.

Representatives of Moody’s Investors Service and Fitch Ratings said they would consider the letter as part of regular efforts to solicit comments from market participants. A Standard & Poor’s spokeswoman declined to comment.

Although companies are assigned ratings based on the probability that investors will lose money on their securities, states and local entities are ranked by their fiscal health.

Only a few of the financially strongest municipal issuers garner top ratings, even though a company is nearly 100 times more likely than a municipal issuer to default on its debt over a 10-year period, according to Moody’s data.