December 13, 2010
This comment concerns an important issue in municipal bond ratings that has escaped the attention of both policy makers and the media, namely, redlining by the credit rating agencies. More specifically, a recent peer-reviewed article of mine in the American Law and Economics Review shows that recent ratings for general obligation (GO) municipal bonds by all three major ratings agencies discriminate against cities with relatively high African American or Hispanic populations. Lower ratings lead to higher interest rates, and my estimates indicate that these cities face a substantial interest-rate penalty when they issue GO bonds.
My article also develops a regulatory framework that would make it possible to detect this type of discrimination in all types of municipal bonds without undermining the credit agencies legitimate business interests or the proprietary nature of their rating schemes. This scheme, which could be implemented by the Office of Credit Ratings at the SEC, would ensure that the credit ratings agencies meet basic standards of fairness.
Thank you for considering this issue.
My article is available at http://aler.oxfordjournals.org/cgi/reprint/ahp013.