PhillyDeals: Do states and towns deserve cheaper loans than business?

Under pressure from Congress, the same credit-rating industry that failed to notice the U.S. home loan market was collapsing is adopting a rosier view of increasingly shaky state and local governments.

Higher credit ratings are supposed to mean lower borrowing costs. That sounds good to hard-pressed officials struggling to balance revenue-hungry budgets without firing workers or boosting taxes.

But there won't be real savings unless people who buy bonds for a living agree they have been overpaid of late.

Starting next month, Moody's Investors Service says it will "recalibrate" the way it rates states and towns, and the risks they won't pay their bills.

Moody's says the switch means "an upward shift for most state and local government long-term municipal ratings by up to three notches."

Let's say ratings on Philadelphia bonds rise three levels, from "BBB" to "A." Under current conditions, that implies a drop in interest rates from about 5.5 percent to 4.7 percent.

This would make this year's planned $145 million Philadelphia bond sale cheaper, by more than $1 million a year. Over time, the city's $3 billion in taxpayer-backed debt would cost millions less, as a result of being refinanced or replaced at lower rates.

Rebecca Rhynhart, the city's treasurer, isn't counting the savings yet. But she's hopeful. "It's definitely a very positive development," she told me. "Going to a global ratings scale makes the municipal ratings more fair. It's something we hope will lower our interest costs."

Still, "it will depend on how the market reacts."

When Wall Street blew up in 2008, borrowing costs spiked, tax collections fell, and state treasurers and legislators squawked at the unfairness:

As big financial companies and automakers felt squeezed, they stiffed bondholders, sought federal bailouts, or both.

But when cities like Philadelphia ran low on cash, they cut programs and boosted taxes to keep paying their bonds.

Citing Moody's and Standard & Poor's data, Dallas Mayor Thomas Leppert told Congress last year that "BBB"-rated cities are less likely than "AAA"-rated corporations to default, and yet some top-rated towns paid as much interest as low-rated companies.

Bills drafted by House and Senate Democrats would force the agencies to rate governments the same as corporations.

When Moody's caved in this week and agreed to rate towns like corporations, Rep. Emanuel Cleaver (D., Mo.), a former Kansas City mayor, and Rep. Michael Capuano (D., Mass.), ex-mayor of Somerville, Mass., urged S&P to follow suit.

"In the last 50 years, only one city, Cleveland, has defaulted," Cleaver spokesman Danny Rotert told me.

"Where is the justification for Moody's, for instance, rating Kansas City at lower rates than AIG? It's to make money. Cities should be getting prime rates. But up until right now, they're getting some of the worst."

Gus Sauter

, chief investment officer at

Vanguard Group

, the largest municipal-bond investment manager, says "sophisticated" bond buyers liked the old rating system because it provided "appropriate differentiation" among high-quality public borrowers.

Moody's new system, Sauter says, "is like mandating that things can no longer be measured in inches - everything has to be measured in feet." It's likely to "confuse" small investors.

Sauter said there's good reason to judge corporate and municipal bonds differently. Congress, "in the 1970s, [exempted] municipal issuers from the same type of registration regulation that corporate bonds would have," he told me. "They're not subject to the Securities and Exchange Commission."

Corporations have to file financial reports four times a year, six weeks after each quarter ends. With many towns, by contrast, "the annual report comes out nine months late," and there's no quarterlies [report], Sauter said.

"We'd like to see more disclosure," Sauter offered, from municipal bond issuers, if bond buyers are going to be asked to accept less interest from the nation's taxpayers.