The Chicago Tribune on Tuesday reported that the Kroll Bond Rating Agency increased its rating for the city of Chicago. The article informs us of the reasoning behind Kroll’s decision, and also how Chicago Mayor Rahm Emanuel appreciated this vote in favor of his financial leadership.
However, the article should be read cautiously.
A credit rating debt upgrade by one firm does not necessarily mean Chicago’s credit quality really improved. If we learned anything from the 2007-2009 financial crisis, bond ratings should not be taken at face value.
Kroll cited the city’s efforts to shore up underfunded employee pension funds as a reason for its upgrade. This may improve credit quality, of course, but improvements for bondholders are not always in the interest of taxpayers and residents.
Higher taxes do not necessarily improve a taxpayer’s financial position.
Kroll upgraded the city two notches, from a BBB+ to A. But those ratings are both at the lower end of “investment grade” ratings. When the average citizen sees that Chicago is now an “A,” they probably need some more context to understand that this does not mean Chicago has gone to the head of the class. Credit rating firms also issue AA and AAA ratings.
Credit rating agencies are not government agencies. They are private-sector firms paid by the issuers of debt, and in this case, the city of Chicago. Their ratings gain regulatory authority because financial regulators have chosen to include their ratings in financial regulation—a practice with a very checkered history, but one that persists today. This might help to explain why BBB+ and A look good on surface, compared to C, D, and F grades, but they are not necessarily great ratings.
The Tribune article stated that “if other agencies eventually follow suit, the city could end up paying less interest on future borrowing.” This indicates that our media apparently has yet to learn “chicken or the egg” lessons from financial markets. They may still give too much credit to bond rating firms for the value of their opinions. Credit ratings often lag, not lead, financial market prices. In other words, Chicago’s interest on future borrowing may fall in the future, in either absolute or relative terms, but credit rating changes may simply reflect market forces already underway.
In turn, market prices and interest rates aren’t always right, either.
More fundamentally, even if the fortunes of bondholders are indeed improving, and the credit rating accurately reflects that improvement, this does not necessarily bode well for the average taxpayer.
Investors may now face a “small risk of loss,” according to Kroll. But for taxpayers it isn’t a matter of risk or probabilities. Their taxes—payments for the city’s dismal financial condition—are certainly going up.