Moody’s shift on muni bond ratings could boost California

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State Treasurer Bill Lockyer’s campaign to get a AAA-credit rating for California is gaining traction.

Moody’s Investors Service, one of the Big Three credit-rating firms, said Thursday it planned to begin rating municipal bonds the same way it rates corporate and foreign sovereign debt.

That could lift California’s debt rating, now fixed at A1 by Moody’s. The Golden State has the lowest credit rating of any state except for Louisiana.

Lockyer, other state treasurers and some in Congress have for months been jawboning the credit-rating firms to change the way they judge the risks of tax-free municipal bonds.

Lockyer’s argument long has been that there is no risk that California could default on its debt because the state Constitution mandates repayment. Given that, he says, the state should get the top rating of AAA.

Moody’s and its rivals, Standard & Poor’s and Fitch Ratings, have used other criteria to grade muni bonds, including issuers’ ability to balance their budgets.

That’s what accounts for California’s low credit grade: The state has a history of busted budgets and borrowing to fund deficits. We’re back in that soup now, facing a projected deficit of at least $15 billion in the new fiscal year.

Despite criticism that it was caving in to political pressure, Moody’s said it would move its muni ratings to a ‘global scale,’ meaning on par with how it judges companies and foreign nations. It will take public comments on the proposed shift until June 30 and announce a timeline in July.

The credit-rating firms don’t have a lot of friends in high places nowadays, given the sterling grades they gave hundreds of billions of dollars’ worth of sub-prime mortgage debt that has since gone bad. So Lockyer struck at a time when the companies were vulnerable to criticism about their rating systems. But he says the muni rating regime has been patently unfair, dooming many issuers to less-than-top-level grades that then force them to pay high interest rates to borrow, or to buy private bond insurance.

Lockyer commended Moody’s on Thursday and said he would ‘work to ensure the system Moody’s adopts for taxpayer-backed bonds places primary emphasis on the risk of default.’

‘We do not oppose the use of other factors,’ he said. ‘But we strongly believe additional factors should have a clear, demonstrated relationship to the risk investors might not get paid.’

It isn’t clear whether S&P and Fitch will follow Moody’s, which is far out front on this issue.

Whether a higher rating would save California much in interest costs remains to be seen. It’s no secret to most big investors that there’s no real risk of the state defaulting. But in markets, perception can count as much as reality, and the state’s ongoing budget woes don’t paint a glowing picture of California as a debtor.

In the long run, though, a AAA rating would help the state attract new investors, including more small investors and foreigners, said Matt Fabian, senior analyst at Municipal Market Advisors in Westport, Conn. Rating muni, corporate and foreign bonds on one scale ‘would make it an easier comparison for investors,’ he said.

And for investors who already own California bonds, any upgrade would be a gift, of course -- and certainly better than a move in the other direction.