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Hot and pricey

The infrastructure bonds that California voters have approved over the years are selling like mad. As soon as state Treasurer Bill Lockyer brings them to market, investors across the country snap them up. That would seem to be a good thing, especially in this time of investor caution. But there’s a catch.

One reason business in California bonds is so brisk is that they carry high interest rates that are attractive to buyers but expensive for taxpayers. When those bonds come due, they may end up having cost Californians far more than expected when they were put on the ballot.

High interest rates make sense when the bonds are risky, but Lockyer and other state treasurers are complaining that their very safe investment-grade bonds are being unfairly downgraded, not because states and local government agencies have become any more likely to default, but because of practices by the three major rating agencies, a crisis in the insurance market and an outdated federal rule. The details of these obscure but vitally important securities practices are scheduled to be taken up Wednesday by the House Financial Services Committee, chaired by Rep. Barney Frank (D-Mass.). The committee should hear Lockyer out. He has a valid point.

The rating agencies -- Moody’s, Fitch and Standard & Poor’s -- score municipal bonds (including state bonds) differently from their corporate counterparts. A corporation’s bond that wins an AAA rating may be a far riskier bet than a municipal bond that scores only AA. In fact, many analysts say that tax-free, fixed-rate general obligation bonds issued by states and local government agencies are generally so safe that all would be rated AAA if judged on the same scale as corporate bonds, despite the high-profile -- but rare -- reports of a city or county defaulting on its bond debts.

It’s fine to say, as bond industry professionals do, that the municipal bond rating scale helps investors distinguish among the very safe offerings. But the more rigorous standards also push interest costs higher for taxpayers by narrowing the market and decreasing demand. Some buyers of corporate bonds are put off by the municipal bond scale. Money market funds are prohibited by a Securities and Exchange Commission rule from buying investment-grade municipal bonds carrying anything but the highest rating, even though they are free to buy riskier corporate bonds that have a lower rating.

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The ratings agencies and the SEC help protect investors and keep them informed, but they also may have combined to cost taxpayers far more than necessary to finance roads, bridges, schools and other infrastructure. It’s in their interest, as well as that of investors and governments, to overhaul their practices.


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