Doubly Bound: The Cost of Credit Ratings

Publications

Tuesday, April 11, 2017

This report, Doubly Bound: The Cost of Credit Ratings, argues that municipalities are assigned credit ratings that are harsher than other asset classes assigned credit ratings. The paper also uses an alternative model—with greater accuracy of past performance and risk— and measures costs that are incurred due to the harsher credit rating.

This increased cost to municipalities included in the study is measured to be $2 billion annually. The paper considers multiple additional costs associated with lower credit ratings—increased interest costs, insurance wrappers, and rating fees.

Lower ratings typically result in higher interest rates – increasing the amount municipal borrowers must repay investors. Low-rated municipalities can purchase insurance to lower their rates, but history has shown that bond insurers are often more risky than the government bonds they ensure. The nexus of low ratings and needless bond insurance provides a mechanism by which the financial industry can extract wealth from local governments.