Lockyer tackles the bond game
California Treasurer Bill Lockyer is embarked on a little-noticed, nerdy but noble crusade. He’s trying to stop Wall Streeters from gouging state and local governments.
That means state and local taxpayers. They’re the ones getting fleeced when their governments issue bonds -- borrow -- to build roads, schools, water facilities and other public works.
It’s a highly complicated subject, and the Wall Streeters like it that way so the public and most politicians -- even state treasurers, until recently -- instinctively shy away.
But perhaps an old quote from political consultant James Carville will help frame the discussion: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter, but now I want to come back as the bond market. You can intimidate everybody.”
More recently in the Nation magazine, columnist Alexander Cockburn characterized one of the bond-rating firms, Moody’s, as a “terrorist blackmailer” prone to behave like “a small-time mobster.”
Lockyer goes on about “rip-offs” and “conflicts of interest” when talking about all three major bond-raters, including Fitch and Standard & Poor’s.
Here’s the problem:
Before a government issues a bond, it must secure a bond rating. It pays a rating agency for that. The higher the rating -- AAA is tops -- the lower the interest rate the government must pay the bond buyers. The rating measures the investor’s risk against repayment default.
Lockyer complains that government bonds are unfairly downgraded because of outdated rating rules, aggravated by a recent crisis created in the bond insurance market when insurers plunged into and were burned by sub-prime mortgages.
The rating agencies force municipal bond sellers -- state and local governments -- to meet higher standards than corporate bond peddlers, Lockyer asserts, and adds: “Taxpayers should be treated the same as corporations.”
I’d say better, since government bonds generally are much safer than corporate bonds.
“The state of California never has defaulted on a bond,” the treasurer continues. “We’re never going to default on a bond. The only way that would happen would be global thermonuclear war where everything shut down. If that happened, our worst problem would not be the bond market.”
S&P; Communications Manager Ed Sweeney responds: “Absence of default doesn’t mean absence of risk.”
But according to Municipal Market Advisors, a municipal bond consulting firm, muni bonds rated only A have
defaulted 10 times less often than corporate bonds rated AAA.
“It’s like you’re a student who aces every test in the semester,” Lockyer says. “The guy who sits next to you gets Bs on every test, but he gets
a better final grade than
you. That’s how the system works.”
In what sounds like some sort of protection racket, if a government buys “insurance,” the rating agency will upgrade the bond. The agency doesn’t sell the insurance, but does get paid annually by the insurer for also rating it. So there’s a symbiotic relationship: The rating agency benefits if the insurer stays in business.
“It’s a conflict of interest; that’s what I think,” Lockyer says.
Everybody makes money except the taxpayers. They lose.
How much? Lockyer estimates $4 billion in extra interest payments over the 30-year life of $61 billion in state general obligation bonds already approved by voters. That’s the difference between a triple-A and single-A rating, amounting to 0.38%. The state’s rating has been averaging single-A.
“That’s awful and it’s a rip-off,” Lockyer says. “It’s
just burning money rather than using it for state services.”
In 2006, state and local governments in California issued $58 billion in bond debt. Last year, they sold $107 billion more. That’s a lot of interest fleecing.
Lockyer recently coaxed 10 other state treasurers, along with some major municipal bond officials, into signing a letter to the three bond rating agencies asking for a better break.
Since then, Moody’s has agreed to take a meandering, convoluted step toward more equal treatment of governments and corporations. Fitch says it’s willing to talk. S&P; has indicated a willingness to chat next time it’s in Sacramento.
Steve Zimmermann, an S&P; managing director, wrote an article for The Times’ blog Blowback last week arguing against a “wholesale” upgrading of municipal bonds.
“Governments and corporations are very different,” Zimmermann wrote. “Corporations can move quickly to restructure, refinance, declare bankruptcy, transfer operations overseas . . . or go out of business altogether. Few of these options are realistically available to governments, which must stay in business where they continue to provide services to their constituents -- even if it means defaulting on their debt.”
Wrong, at least for the state of California. The state Constitution requires it to make all general obligation bond payments. Anyway, how does a corporation’s ability to declare bankruptcy or go out of business make its bonds safer than Sacramento’s? I tried to ask Zimmermann, but he didn’t call back.
Meanwhile, state Controller John Chiang last week declared that California should consider boycotting S&P; “until they constructively engage” in reform.
“That sounds like a lot of political noise,” says John Cummings, executive vice president of Pacific Investment Management Co. in Newport Beach.
But Cummings does agree with Lockyer. “Municipal bonds are underrated,” he says. “There needs to be an intellectually honest rating so investors can accurately assess a bond’s risk.”
I asked Lockyer how he was going to win this battle.
“By the old LBJ rule,” he answered. “Get ‘em by the right body part and their hearts and minds will follow.”
The only body part a Wall Streeter really cares about is the wallet.