Wednesday, August 3, 2011

Grades: Washington, D+. Richardson, AAA

Congress finally raised the debt ceiling. Whew! I know, it's crazy when the question whether the government will pay its bills is considered iffy, but for a while there it was in doubt. Refusing to raise the debt ceiling is like a homeowner worrying that maybe he bought more house than he can afford and deciding to "solve" his problem by stopping payment on the mortgage. The tea party caucus in Congress urged the country to become a deadbeat and pretend it's being fiscally responsible. Luckily, saner heads prevailed. (Unfortunately, what the "saner" heads came up with is not going to help the unemployment numbers, but that's another story.)

After the jump, the impact on Richardson.

Damage from a federal default would not have been contained in Washington. I blogged before about how a downgrade on federal debt by the credit rating agencies would have a ripple effect that could significantly increase the cost of borrowing for Richardson. The city eventually acknowledged the risk in a blurb in last week's "Week in Review":
"The City of Richardson is among 177 local governments across the nation with a Aaa rating being notified by the Moody's rating agency that its bond ratings will be reviewed due to the finance debacle occurring in Washington D.C."

But the city offered no analysis of what such a downgrade would mean to Richardson. It means it would increase the cost of borrowing. It would make it more expensive to carry out Richardson's 2010 bond program. It could force Richardson to delay or scale back on capital improvement projects. How big an impact? We don't know. Either the city didn't do the analysis or it didn't share it with the public. Planning for the 2011-2012 budget seemed to be going forward as if this risk didn't even exist.

Now that the federal government has raised the debt ceiling, the risk to Richardson is lessened. The city's Aaa credit rating appears to be safe, at least until the next crisis in Washington. But that's not the ending that some in the community want you to take away from this crisis. The critics' argument seems to go like this. The credit rating agencies (Moody's and Standard & Poor's) cannot be trusted. They've gotten it wrong before. Richardson's Aaa rating is supported by its ability to tax. One critic even accuses city officials of bribery -- wining and dining and buying its Aaa credit rating. So, Richardson's Aaa rating is unjustified. Richardson rushed its 2010 bond program out of fear that the Aaa rating was a bubble about to collapse. Anyhow, all that seems to be how the critics' argument goes.

There is just enough resemblance to some facts in this indictment to make the whole appear plausible to the casual reader, but evidence is either sketchy or lacking altogether and the logic is flawed. The critics are correct that the rating agencies share the blame for the nation's financial crisis (see the postscript below). Regardless what we may think of the rating agencies, the truth is that investors rely on them. Regulators rely on them. They supply a widely-used, standardized measure of the credit-worthiness of borrowers. Trust them or not, their ratings determine the cost of servicing the city's debt.

The critics are certainly wrong when they accuse the city of bribing rating agencies. But they are correct that the city government's power to tax increases its ability to pay back what it borrows, thus making the city more credit-worthy. But that's a point in Richardson's favor, not evidence that Richardson's credit rating is undeserved. Moody's also credits Richardson's "strong financial management with historical stability demonstrated by consistent fund balances that have been maintained through economic downturns; and a manageable debt position."

Richardson and every other business or government body wanting to invest, wisely looks to invest when the cost of borrowing is low. Interest rates are at historic lows right now, and Richardson's good credit rating means Richardson's cost of borrowing is at the low end of these low interest rates. That's an excellent time to invest in capital improvement projects. Now that the federal government has taken default off the table, Richardson can and should continue to take advantage of this opportunity to invest in Richardson at a historic low cost.

P.S. Read "All the Devils are Here" by Joe Nocera and Bethany McLean for an excellent history of the financial crisis, including the role played by the rating agencies. Here's a choice excerpt: "In retrospect, the surprise is not that the rating agencies would eventually be corrupted by their business model, but that it took so long to happen." And read "Moody's Junkies" by Bethany McLean in Slate for why those same rating agencies that everyone hates are still indispensable to the world financial system.

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