Why do cities pay more than businesses to borrow money?

Unlike AIG, GM or Lehman Brothers, states and towns haven't been going bankrupt. Yet taxpayer-funded local governments still have to pay more than business corporations to borrow money from investors through the bond market.

"A double-A municipal bond, using a Build America bond as an example, will have a similar yield to a BBB corporate bond," notes Gus Sauter, chief investment officer at Vanguard Group, which buys more muni bonds than anyone.

"That is because there is less liquidity in the municipal bond, which is driven by less rigorous financial disclosure, smaller deal sizes and less coverage by institutional analysts."

There's hope (and fear) this could change, because Moody's, one of the big rating agencies, under pressure by Congress, says it will upgrade most municipalities "three notches" under new rules next month. More in my PhillyDeals column in today's print Inquirer, here.

Will higher ratings mean cheaper borrowing? Public officials hope so, but don't hold your breath. These "rating increases do not indicate improved credit quality," warns Janney Capital Markets analysts Alan Schankel and Tom Kozlik in a report to clients. Still, "the perception of improvement, particularly from retail [small, individual, unsophisticated] investors, should lead to marginal trading level increases for many of the bonds."

Higher price would mean lower yield, or cost, for future issues -- good news for public borrowers. "Particularly for smaller issuers," Matt Fabian of Connecticut-based Municipal Market Advisers tells me.