Monday, June 29, 2009

Good Bond Rating Not Always Good For Citizens

From time to time this blog features posts about "bonds", which many people will remember are secret tools of high finance that are given to people who are either (1) awarded an MBA or (2) sworn into public office.

The city, possessing access to these bonds, can periodically issue them for the purpose of raising money to pay for things. Since the bond is a loan from an investor, the city must repay the value of the bond plus interest in order to attract said investors.

So, how do we know how much interest is paid? One determinant is the city's bond rating, which is issued by Fitch's, a company that gets paid to come up with bond ratings. The city recently issued $26,970,000 in bonds, which were rated at AA+. (The highest rating is one level above this: AAA).

The city was quick to tout the AA+ rating, and the story is featured on the city website. From the whole report, the city selected some excerpts that they use to propagandize the public:
Fitch Ratings assigns an 'AA+' rating to Annapolis, Maryland. The 'AA+'
rating reflects the city's stable employment and tax base, strong financial
position, and moderate direct debt burden.

The city's financial condition is strong, characterized by ample
reserves in the general fund.

The Stable Outlook reflects Fitch's expectation that the city will
maintain a healthy level of financial flexibility through prudent fiscal
management, despite broader recessionary pressures and a softening real estate

Now, a higher bond rating typically means a lower interest rate that the taxpayers have to pay back to the investors, which is a good thing. And, the report points out several features of city finance that are indeed good. BUT, a good bond rating is not always a good thing!

A bond rating is solely a measure of the city's ability to repay its bondholders in the future. Potential investors can then use the rating to assess the default risk of a bond, and can determine the rate of return they need to receive to take on the risk of loaning money to the city. A bond rating is a pricing mechanism--it reflects certain financial practices of the city, BUT IT ALSO REFLECTS THE CITY'S ABILITY TO STICK IT TO THE TAXPAYERS. A spend-happy city could still receive a good rating if they've proven they are committed to raising more taxes. This could be accomplished through rising home values, higher tax rates, or development of new taxable properties. Take a look at some of Fitch's specific observations:
City efforts to expand and diversify the tax base through redevelopment and
periodic annexations have been successful, with the recent opening of the Park
Place mixed-use development, which includes a 225-room Westin hotel.

Long-term development prospects are constrained due to the limited land
area and the large portion of the city that is considered historic.

So, to maintain a good bond rating, the city's first option is to expand the tax base by allowing development. Is this a good thing for citizens? Many would say no--think 1901 West. As the land becomes more scarce, the city will be pressured to either reduce spending or raise the tax rate. Which do you think they will do?!

Beware the sound of one hand clapping.

1 comment:

Anonymous said...

What's wrong with 1901 West?