Moody’s Assigns Negative Outlook to US Local Governments « naked capitalism

Tuesday, April 7, 2009

Moody’s Assigns Negative Outlook to US Local Governments

Given the deterioration in local tax bases, it may seem surprising this Moody’s negative outlook for states and municipalities wasn’t issued earlier. However, this is the first time that the rating agency has provided a warning across a class of borrowers. However, despite the grim tone, in fact municipal borrowers (save industrial revenue bonds, in which payments come from a particular project, not a taxing authority) even when they default are much less problematic than corporate borrowers. Historically, they miss a payment or two but do not default on principal. Even if government borrowers in this cycle required more significant restructurings than in the past, they are still likely to perform better than a defaulting corporate borrower,

From Bloomberg:

U.S. local governments were assigned a negative outlook by Moody’s Investors Service, the first time the New York-based credit rating company gave such an assessment to the overall group of debt issuers.

The collapse in housing, turmoil in financial markets and what may become the broadest and deepest national recession since the 1930s will pressure “many if not most local governments” over the next 12 to 18 months, Eric Hoffmann, a Moody’s analyst, said in a news release today.

Moody’s cited “unprecedented fiscal challenges” faced by American counties, cities and school districts after a month when the U.S. unemployment rate jumped to a 25-year high of 8.5 percent. The gauge may reach 10 percent by 2010, the company said, citing some economists’ forecasts.

Investing in local government debt “demands greater attention” to credit analysis than for states, which have more power to balance their budgets and can’t declare bankruptcy, BlackRock Inc. municipal-bond portfolio managers led by Peter Hayes said in a report this month.

“Local governments have a higher risk of default and may declare bankruptcy, but bankruptcies, if any, will be minimal and isolated to mismanaged and weak credits,” BlackRock said…

The localities most at risk of having their Moody’s bond ratings downgraded will be those with: industries such as real estate, auto manufacturing or financial services; reliance on falling revenue sources such as sales and real-estate transfer taxes; volatile variable-rate debt; and a high proportion of fixed or legally mandated costs, according to today’s report.

10 Comments:

john bougearel says:

April 7, 2009 at 2:44 pm

Yves,

Your irony is rich and makes me laugh when you say “it seems surprising Moody’s negative outlook on local govt’s wasn’t issued earlier.”

Since when has Moody’s been forward-looking in this financial crisis? They way they drag their feet, you’d think they were a public entity charged with overseeing that nothing negative gets leaked out that doesn’t have to be leaked out. As a rating agency, they have failed miserably in their mission to protect investors who thought they owned gilt-edged AAA rated securities in their portfolios that began blowing up more than 18 months ago.

Yves Smith says:

April 7, 2009 at 2:53 pm

John,

True in general, but the agencies are now trying to look responsible by issuing downgrades promptly upon occasion, and they seem to pick the worst instances. Look at how they downgraded Bear on a Friday when rescue talks were underway. That led to the initial 28 day loan from the Fed (or was it Treasury?) being yanked and Bear being put down.

Leo Kolivakis says:

April 7, 2009 at 3:02 pm

Wait till Moodys looks into local governments’ underfunded pension plans. Next up, downgrading state governments. Don’t you love these ‘forward looking” credit agencies?!?

Cheers,

Leo

In Debt We Trust says:

April 7, 2009 at 3:03 pm

Things would be so much simpler if we had a CORPORATE bond exchange – that way the market (and not Moody’s, Fitch, or S+P) can be the raters.

Yves Smith says:

April 7, 2009 at 3:50 pm

In Debt,

The problem is corporate bond don’t trade often enough for them to be exchange traded. Unlike stocks, where every time IBM issues stock, the shares all are the same, each issue is distinct.

However, in the stone ages (before credit default swaps), you could price them quite reliably using ratings and maturities as a starting point. Investors would consistently recognize when a company’s credit was deteriorating and would reprice it accordingly, usually well before a downgrade.

OSR says:

April 7, 2009 at 3:54 pm

“Local governments have a higher risk of default and may declare bankruptcy, but bankruptcies, if any, will be minimal and isolated to mismanaged and weak credits,” BlackRock said…”

Now there is one of those quotes that will be fun to save somewhere and revisit in a year.

Here is another one: Due to unemployment, tax and assessment protests, pension liabilities, crime, and inflation, municipalities, if not states, will default in record numbers within the next 24 months. Any federal aid will be marginal, when compared with what the banks are currently seeing. (And it will be sunny, breezy, and 68 degrees on 6/1/11)

Anonymous says:

April 7, 2009 at 4:11 pm

Who believes rating agencies anyway?

Anonymous says:

April 7, 2009 at 4:12 pm

So, if derivatives were thought to be weapons of mass destruction when introduced and have proven themselves to be such in practice, why aren’t they outlawed?

When are folk going to start talking about making them illegal?

This is worse than a Harry Potter book where you can’t call the bad guy by his real name and have a dispute out in the open about the perils of investment banking schemes like derivatives.

psychohistorian

In Debt We Trust says:

April 7, 2009 at 8:43 pm

Yves,

I know corp bonds are relatively illiquid compared to sovereign debt or equities.

In the equity markets we also have illiquid issues. They are listed on the pink sheets.

But CDS are arguably a type of bond future all on their own right?

If we can trade eurodollar futures, 30 year futures, and fed fund rates futures then why not something equivalent for CDS?

john bougearel says:

April 7, 2009 at 10:05 pm

Yves,

Good point on how they undermined the rescue talks underway on Bear Stearns. The ratings downgrade would have forced pension funds and other institutional fixed income investors to immediately close out any loans extended to Bear. These forced sales were not helpful.

If the rating agencies had just waited a week, Bear would have had access to the new lending facility the Fed was opening up the following week. Bear could have lived to see another day.

From an investor’s perspective, those who succeeded in recognizing credit risks deteriorating also know that if the credit has been repriced cheaper ahead of the credit rating downgrade, that it would be soon time to jump back in. That is, the rating agencies function as a lagging indicator for investors.

Unfortunately, the less sophisticated investors who have to rely on these agencies do not know that they are lagging indicators. If Moody’s is now trying to be more a tad more responsible and forward-looking in their credit ratings, well god bless em. But,the best the agencies can hope for is to be somewhat of a coincident indicator that recognizes credit risks as they escalate. In this regard, they function as merely a sports radio announcer. They can only call the credit downgrades from their radio booths as they happen. If they become too forward-looking, they will encounter significant push back from the munis and corporations they rate. Again, the less sophisticated investor does not know that when a local govt or corporate entity gets downgraded from AAA to A- that that credit rating downgrade is actually just the first few innings. The hapless investor thinks he is buying relative safety in A-, unawares that as and when credit deteriorates further towards junk status his investment loses money. Far too many investors believe those ratings to be relatively static, rather than moving targets, and in this economy, those moving targets are can be extremely volatile. How many times did we see AAA go to junk relatively overnight?

And Leo makes a good point: wait until the local govt’s are forced to admit how underfunded their pension plans are. Then the agencies will have to reflect that new datum in their ratings. It is not however that Moody’s does not know the pension plans are underfunded but have to wait for the fullness of time for that to be revealed by the local govt agencies(and corp entities too)

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