ExecutiveSummary

The2015filmTheBigShorthasavividsceneofananalystworkingforaratings
agency,S&P,evaluatingfinancialproductsthatlaterturnedouttobetoxic.The
questioneraskstheanalystiftheyveevergivenaratingnotdesiredbythebanks.
Theanalystcantanswer,andpointsoutthatifshegivesaworserating,theylljust
gotoMoodys.

Thethreemainratingsagencies--Moodys,S&P,andFitch--exerciseanenormous
amountofinfluenceovertheglobaleconomy.Theirratingsdeterminethe
creditworthinessofmajorcorporations,banks,nearlyallbondissuances,cities,
states,evensovereigngovernments.Theirauthorityisenhancedincountlessfederal
andstateregulations.Thoseregulationsmandatethatbanksandinsurance
companiesholdonlyhighly-ratedbonds.Asaresult,apoorratingfromanyofthe
ratingsagenciescancostanyissueragreatdeal.

Butitcoststhepublicthemost.Thisreportdelvesintothestateandlocalbodies
thathavebornethebruntoftheratingsagenciestwostandards:onefortheprivate
sectorwheretheirprofitsarehigher,andoneforthepublicsector,wheretheprofits
arelower.Whiletheprivatesectorconsistentlygetsgreatratings--includingforthe
typesofsecuritiesbehindthefinancialcrisis--thepublicsector,inparticularthe
StateofNewJersey,ChicagoPublicSchools,Jackson,MS,andNewark,NJ--getsleft
withsubparratingsthatmassivelyincreaseborrowingcosts.

Thisreportexposesthewaysinwhichtheratingsagenciesusetheiroligopoly
againstthepublicinterest,andthetacticsthatunions,communityorganizations,
cities,counties,andstatescanusetofightback.

KeyFindings:

Massiveinconsistenciesbetweenratingsofmunicipalbondsandprivate
sectorbondscontinue,sixyearsafterDodd-Frankmandatedan
across-the-boardstandardization.Inplacestargetedbyratingsagencies,
thecostsratchetupmassively.
Theratingsagencieshavelaunchedanunprecedentedattackoncollectively
bargainedpublicpensionsandretireehealthcare.
Racialdisparitieswithinthemunicipalbondmarketarepersistent,with
nearlyallofthecitiesandstatesatthebottomoftheratingsscalebeing
majority-minority.

1
Theconsequenceoftheongoingbadbehaviorbytheratingsagenciesisadeeply
skewedmarketformunicipaldebt,tiltedtowardsfinanciersandagainstthepublic.1

GlossaryofTerms:
Municipalbonds
Municipalbondsaredebtsecuritiesissuedbycities,counties,schooldistricts,public
authoritiesandstates.

Municipaldefault
Whenamunicipalitymissesadebtpayment.Municipaldefaultsareextremelyrare.

Municipalbankruptcy
WhenamunicipalityentersChapter9ofthebankruptcycode.Municipal
bankruptciesarealsoexceedinglyrare.

Ratingsagency/NRSRO
Therearethreeagenciesthatconsistentlyratebothpublicandprivatesectordebt:
Moodys,S&P,andFitch.Theywerealsothefirstthreeratingsagenciesgrantedthe
nationallyrecognizedstatisticalratingsorganizationdesignationwhenit
emergedin1975viaanSECrule.Assuch,theyconstituteanoligopoly.Ratings
agenciesaresupposedtoassessthecreditworthinessofanissuer,ie,thelikelihood
ofanissuertodefault,andthenassignarating.Ratingsagenciesareusuallybutnot
alwayspaidbytheissuertorateabond.Profitsonratingsareconsiderablyhigherin
theprivatesector.Moodysisbyfarthelargestraterofpublicsectordebt.Many
smallermunicipalities,includingNewark

Bondcreditrating
Moodys,Fitch,andS&Pallhaveslightlydifferentratingsystems,butgenerally
theytendtorangefromAaa/AAAatthetopofthescaletoCandthendefaultatthe
bottom.Ratingsdeterminethecostofservicingdebt.Banks,insurancecompanies,
andmanypensionfundsarerequiredtoholdcertainamountsoflow-riskreserves,
whichmustbeinvestment-gradebonds.Whenbondsaredowngradedbelow
investmentgradestatus(Baa3orBBB-arethelowestinvestmentgraderatings),
banks,insurancecompanies,andmanypensionfundsmustselloffthoseassets,
whichincreasethecostofborrowingsignificantlymoreforissuers.

Generalobligation(GO)debt
Generalobligationisthetraditionalformofmunicipaldebt,securedatleastbythe
fullfaithandcreditofamunicipality.Otherformsofnon-GOdebtincludespecial
revenuebondsandpensionobligationbonds.

1
The issues surrounding ratings agencies have been extensively discussed, largely in the way in which
they enabled predatory behavior in the lead-up to the financial crisis. This report is the first treatment that
calculates the cost of unfair ratings to targeted municipalities, states, and school districts.
2


TwoStandards,OneRule

InNovember2002,Moodyspublishedareport2thatwasastoundinginitshonesty.
Moodysadmittedthattherewaslittleifanyjustificationforitstwo-tieredsystem
forratingbonds:onestandardforcities,countiesandstates,andanotherforWall
Streetandthecorporateworldgenerally.Theratingsagencyeffectivelyconceded
thattherewasnojustificationforchargingsignificantlyhighercreditcoststolocal
governments,coststhatresearcherswouldlaterestimateatover$1billionannually.
3

Indeed,Moodysnotedthat:

Ifmunicipalitieswereratedonthecorporatescale,Moody'swouldlikely
assignAaaratingstothevastmajorityofgeneralobligationdebtissuedby
fiscallysound,largemunicipalissuers.Likewise,Aaaratingswouldlikelybe
assignedtothebulkoftheseniorobligationsissuedbylarge,fiscallysound
municipalprovidersofessentialservices.TheratingcategoriesbelowAaa
wouldbepopulatedbydebtofissuersthat(1)wereexperiencingfinancial
stressor(2)didnothavethefinancialresourcesorfutureresources(limited
taxbaseorservicearea)towithstandsomeminimumleveloffinancialstress.
Moody'sexpectsthatnearlyallperformingmunicipalgeneralobligationand
essentialservicerevenuebondswouldberatedAa3orhigherifratedonthe
corporateratingscale.

Despitethepublicationofthe2002report,Moodysfailedtochangeitsrating
systemuntil2010,whenhundredsofcitiesreceivedupgradesof1-2notchesintheir
creditrating.ThechangesmadebyMoodysdidntcomeaboutasaresultof
internaldeliberations,butratherbecauseofsignificantpressurefromoutside.
Dodd-Frankspassagein2010mandatedthatratingsagenciesapplythesame
standardstoallissuersofdebt,publicorprivate.4Andtheagencyhadbeensuedby
then-ConnecticutAttorneyGeneralRichardBlumenthalin2008,5arguingthatthe
two-tiersystemartificiallyincreasedthecostofdebtservicingforcitiesandtowns.

Butwhiletheratingsupgradesforcitiessignificantlyreducedtheamountspentto
serviceWallStreetdebt,badbehaviorbytheratingsagenciesdidnotend.The

2
Special Comment -- Moodys Municipal Bond Rating Scale. Moodys. November 2002.
3
Credit Ratings and the Cost of Municipal Financing. Jess Cornaggia, Kimberly Cornaggia, and Ryan D.
Israelson. March 21, 2014.
4
Americans for Financial Reform SEC Comment Letter on NRSRO Regulation. April 1, 2014.
5
Attorney General Sues Credit Rating Agencies For Illegally Giving Municipalities Lower Ratings,
Costing Taxpayers Millions. Connecticut Attorney Generals Office Press Release. July 30, 2008.
3
Dodd-Frankrulemandatinguniversalratingshasbeenconvenientlyelidedbythe
agencies,asthefollowingcasestudiesshow.Thisisevidencedbythecostsof
subparratings--amorerecentexaminationfromformerMoodysanalystMarcJoffe
estimatesthecostsofartificiallysubparratingstopublicentitiesas$1.6billion
annually.6

Onerecentexamplestandsout.InAugust20167,FitchRatings,followingits
competitors,issuedajunkbondratingofB+forChicagoPublicSchoolsgeneral
obligationdebt.ChicagoPublicSchoolsservesover390,000studentsandhasnearly
60,000employees.Itisthenationsthird-largestschooldistrict,andrespected
analystshaveconcludedthatthelikelihoodofdefaultislow.Cities,counties,states
andschooldistrictsrarelyifeverdefaultontheirbonds,andIllinois,unlike
Michigan,hasnoprocessformunicipalbankruptcy.

Intheexplanationfortherating,FitchextensivelydiscussesCPSpension
obligations.ButitneglectstomentionthatChicagoPublicSchoolshasneverhada
defaultinthemodernera.Theexplanationdoesntdeigntomentionatalltheactual
likelihoodofChicagoPublicSchoolstodefault.

Fourmonthslater,Fitchissuedanotherrating:AAA8,thehighestpossible,fora
bondofatrancheofresidentialmortgage-backedsecuritiesthatdonothave
backingfromthefederalgovernmentoranaffiliatedenterpriselikeFreddieMac.

Itwasthesekindsofmortgage-backedsecuritiesthatwereatthecenterofthe
financialcrisisandtheassetsthatwerepurchasedbythefederalgovernments
TARPprogram.

Giventhatresidentialmortgagebackedsecuritieshaveafarriskierhistory--the
foundationstoneofacreditrating--thanChicagoPublicSchools,Fitchsrating
practicesrevealashockingassaultonthechildrenandteachersofChicagowhilethe
worstpracticesofWallStreetarere-enabled,increasingthelikelihoodofanother
financialcrisis.

PrivateSectorWipeouts
Moodys,S&P,andFitchsbehaviorinthefinancialcrisiswasabhorrent.Moodys,
S&PandFitchinflatedratingsofriskyWallStreetfinancialproductstothehighest

6
Doubly Bound: The Cost of Issuing Municipal Bonds. Marc Joffe, Haas Institute for a Fair and Inclusive
Society and the ReFund America Project. 2015.
7
Fitch Rates Chicago Board of Education, (IL) ULTGOs 'B+'; Outlook Negative. Fitch Ratings Press
Release, August 30, 2016.
8
AAA Grades Return for Securities Backed by Riskier Mortgages Matt Scully, Bloomberg. December 7,
2016.
4
possible,Aaa,inordertogainbusiness.HoldersofsomeoftheAaabondswere
wipedout.S&PandMoodyshavehadtopayfinesofover$2billioninresponseto
theirmisbehaviorinthefinancialcrisis.Thatmisbehaviorwascenteredonthe
ratingsagenciesinflatingtheircreditratingsofcomplexfinancialproductssoasto
gainmoreprofits.

TheFinancialCrisisInquiryCommissionfound9that80%ofAaabondholdersof
precrisiscollateralizeddebtobligations(CDOs)sufferedlossesintheaftermathof
thefinancialcrisis.10%ofAaabondholdersofresidentialmortgage-backed
securities(RMBSs)sufferedlossesinthesametimeperiod.

Inthecorporateworld,similarproblemsemerged.Moodysdidnotdowngrade
LehmanBrothersbelowA1--thefifth-highest,wellintoinvestmentgrade--until
July2008,wellafterthebanksproblemshadbeenpublicized.Lehmanbondholders
ultimatelyreceivedabout25centsonthedollar.10Moodysdidnotdowngrade
WashingtonMutualbelowA2untilthefallof2007.WashingtonMutualbondholders
onlyreceivedabout26centsonthedollarfortheirbonds.11

LossesByHoldersofBondsInitiallyRatedAAA,2006-2016

CDOs ~80%

RMBSs ~10%

Municipal 0%

ThedegreetowhichtheimpairmentforAaabondholdersofWallStreetcomplex
financialtransactionscontrastswiththemunicipalbondmarketisimpossibleto
overstate.Inthefive-yearperiodleadinguptoadefault,notasingledefaulting
municipalissuerhadaAaarating,accordingtoMoodysownresearch.12

Tocomparetothepre-crisisratingsforfinancialfirmslikeLehmanorWashington
MutualtoamunicipalissuerlikeDetroitalsoobservessignificantdisparities.Detroit
generalobligationbondholdershadarecoveryrateof41to69centsonthe
dollar--faraboveWaMuandLehman.YetayearpriortotheDetroitbankruptcy,

9
Credit Ratings and the Financial Crisis. Financial Crisis Inquiry Commission, Preliminary Staff Report.
June 2, 2010.
10
Lehman Recovery Seen as Justifying $2 Billion Bankruptcy. Erik Larson, Bloomberg. September 11,
2013.
11
Corporate Default and Recovery Rates, 1920-2008. Moodys Investor Service Special Comment.
February 2009.
12
US Municipal Bond Defaults and Recoveries, 1970-2014. Moodys Investor Service Special Comment.
July 24, 2015.
5
neitherclassesofgeneralobligationdebtwereratedinvestmentgrade,instark
contrasttothetwobanks.13

Itsalsoworthlookingattherecordoftheratingsagenciesinrelationtobond
insurancefirms.Intheleaduptothefinancialcrisis,bothAmbacandFGICwere
ratedAaa.Butby2010,bothhadfiledforbankruptcy.

CreditEvents
Thatmunicipalitieswouldconsistentlyberatedharsherthantheprivatesector,in
lightoftheratingsagenciesbehaviorduringthefinancialcrisis,isgalling:itresults
inincreasedwealthtransferstoWallStreet,attheexpenseofthemunicipalities
leastabletoaffordit.

Butevenmoreso,thestringentburdenonmunicipalissuersdoesntmakesensein
lightoftheglaringlegaldifferencesgoverningdefaultandbankruptcyinthepublic
andprivatesectors.

Defaultsoutsideofbankruptcyareincrediblyrare.Thefollowingcasestudies
illustratetheconsequencesthatmunicipalitiesfacewhentheyrunafoulofMoodys
andS&P,andtheconsequencesthatthepublicencountersasaresult.

Thefollowingcasestudieswerechosenasexamplesofcitieswithlowratings.New
Jerseyisthesecond-lowestratedstate,whileChicagoPublicSchoolsisthe
lowest-ratedschooldistrict.NewarkandJacksonarebothamongthelowestrated
citiesinthenation.

MoodysperformsfarmoremunicipalratingsthanS&PandFitch,whichiswhythe
agencygetssignificantlymoreattentioninthisreport.

StateofNewJersey
Totallossestounfairratings:$222millionannually

OnMarch27,2017,MoodysfurtherdowngradedNewJerseyscreditrating,toA3,
sixnotchesbelowAaa.Thedowngrade,whichaffects$37billionworthofstate
debt,isthelatestinalongstreamofdowngradesofthestatesdebtfromratings
agencies.

TheartificialloweringofNewJerseyscreditratingbyMoodys,S&PandFitchwill
costNewJerseytaxpayers$258millionannually.14Thatcostexceedsthetotal

13
Ibid.
14
This is based on a 0.6% spread between an index of 20-year Aaa-rated municipal bonds and an index
of 20-year A-rated municipal bonds. As of March 23, 2017, the Aaa index returned 3.35% and the A index
6
annualamountthatthestatespendsonenvironmentalprotectionbyover$30
million15

TheStateofNewJerseyhasneverdefaultedonitsobligations.AUSstatehasnot
defaultedonitsdebtinover80years.YetMoodysdecidedtodowngradeNewJersey
toaratingthatputsitbelowthebeforementionedratingofWashingtonMutualin
2007,wellafterthebanksproblemshadbeendescribedinthemedia.

AdefaultbytheStateofNewJerseyisunthinkable.USstatescannotgobankrupt.
Moodysframedtheproblemasanissueofhighlong-termpensionobligations.16
Butaratingissupposedtomeasurethelikelihoodthatpublicentitywilldefaulton
itsdebt,notoutstandingobligationsthatareamortizedover30years.

Outsideofitspensionobligations--whichhaveneverledtoadebtdefaultinthe
historyofthemunicipalbondmarket--NewJerseymayhavefiscalissues.But
whetherornotthoseissuesindicatealikelihoodtodefaultisnotevident.Fromthe
datasetofUSstatedefaults,Moodysisratinginanenvironmentinwhichthereare
nodefaults,andasaresult,noindicationthatNewJerseywilleverdefault.

GivenbothNewJerseyasanissueranditspeergroupssterlingrecordformeeting
itsobligations,MoodyshasnoexcusebuttorateNewJerseys--andallUS
states--obligationsatAaa.

ChicagoPublicSchools
Totallossestounfairratings:$290millionannually,plus$234millionin
one-timepayments

Thisyear,theadministrationofChicagoPublicSchoolsthreatenedtocloseschools
threeweeksearly,asaresultofapurportedcashcrunch.Thiscomesontopofyears
ofschoolclosures,andpositionsleftvacant.80%ofChicagostudentsareeligiblefor
federalmealprograms.

InSeptember,17Moodysdowngraded$5.8billionworthofChicagoPublicSchools
debttoB3,fifteennotchesbelowAaa,andsixnotchesintojunkcategory.The

returned 3.97%. Given that some lower interest rates from when the state was rated higher are locked in,
this is an estimate of future losses if the current rating persists.
15
Fiscal Year 2017 Detailed Budget. State of New Jersey.
16
Rating Action: Moody's downgrades New Jersey's GO rating to A3; outlook stable. Moodys. March 27,
2017.
17
Rating Action: Moody's downgrades Chicago Board of Education, IL's GO to B3; outlook negative.
Moodys Investor Service. September 26, 2016.
7
downgradeddebtinChicagowillcostthecity$290millionannuallyrelativetoAaa
debt.18

InFebruary,theschooldistrictcut$31million19tolocalschools--moneythatwould
helpgotoprovideforadditionalprogrammingforchildren,likearts,music,
physicaleducation,andfieldtrips--tooffsetthelossofstateaid.Butthecostof
higherdebtservicedwarfssixfoldthelossofstateaid.

Thatdoesntincludeothercoststothedowngrade.Thankstocomplexinterest-rate
swapdeals,ChicagoPublicSchoolswasforcedtopayoutanadditional$234million
20
inswapterminationfees.Afterbeingsoldontheriskyswaps--whichare
supposedtoguaranteeafixed-ratetomunicipalissuerswhentheymakethe
haphazarddecisiontoissuevariableratherthanfixed-ratedebt--ChicagoPublic
Schoolspaidtheterminationfeestheswapscontractsmandatedwhendistricts
creditratingcratered.

TheratingsdowngradesforChicagoPublicSchoolswerecoextensivewithratings
downgradesfortheCityofChicago,whichMoodysjustifiesinpartbysayingthat
ThefiscalstressofChicagoPublicSchools(CPS,B3negative)alsoposessomelong
termriskstothecity.SustainedfiscalstressatCPScouldpressureChicago'scredit
profileinvariousways,fromconstrainingthecity'spracticalabilitytoraiserevenue
forcityobligationstoraisingthecity'sborrowingcosts.Thecityiscurrentlyrated
atBa3,twelvenotchesbelowAaa.Theratingsdowngradecoststhecity
approximately$113millionannually.21

Onepotentialconflictofinterestwiththecitysinterestrateswapshasemerged.A
totalof$35millioninswapterminationfeeswerepaidtoWellsFargo(amongother
banks).Interestingly,WellsFargoandMoodysbothsharealargestshareholder:
WarrenBuffettsBerkshireHathaway.Buffettisnotoriouslyactivewithhispositions
incompanies.WellsFargoandMoodysarebothamongBerkshireHathaways
largestpositions.Thetimeline,then,isthus:Moodys--Buffetts11th-largest
position--downgradesChicagosbondratingintojunkstatus.Inturn,thecitymust

18
Based on an estimated 5% spread, which likely understates the cost. Moodys 20-year index reports
Aaa bonds at a 3.35% average, while in a February 2016 bond offering, CPS paid 8.5% interest rates.
See CPS borrows $725 million at extraordinarily high interest rate. Heather Gillers, Chicago Tribune.
February 3, 2016. Given that some lower interest rates from when the school district was rated higher are
locked in, this is an estimate of future losses if the current rating persists.
19
Former CPS Leader Calls Out Cuts to Low-Income, Minority Schools. Nick Bloomberg, WTTW.
February 27, 2017.
20
Turned Around: How The Swaps That Were Supposed To Save Illinois Turned Toxic. Saqib Bhatti
and Carrie Sloan, ReFund America Project. January 2016.
21
Based on a 2.3 percent spread, as estimated by Bloomberg. Chicago Returns to Municipal Market
After Record Tax Hike. Elizabeth Campbell, Bloomberg. January 12, 2016.
8
payoutmillionsinterminationfeestoWellsFargo,Buffettssecond-largest22
position.23

ChicagoPublicSchoolshasntdefaultedonadebtobligationsince1943.Withthe
debtratedintojunkterritory,farfewerinvestors--inparticular,banksand
insurancecompanies--canholdthedebt,drivingupthecostsevenmore.In
February2016,a$725milliongeneralobligationissuancebyCPScarriedan8.5%
yield,comparedtoaAaaaverageyieldof3.35%.The2016issuancealonewillcost
Chicagoschoolchildrenover$35millionannually.

TheSeptember2016ratingsdowngradefollowedastringofotherdowngrades.And
beyondthehighinterestrates,WallStreetwalkedtothebankintwootherwaysas
well.

InitsstatementreviewingthedecisiontolowerCPScredit,Moodysnotedthatthe
newratingincorporateselevateddebtserviceexpensesthatincludeinterest
ratesofupto9%onGObonds.SuchastatementfromMoodystypifiesthe
classicaldefinitionofthetermchutzpah,giventhatitwasMoodysownactions
thatcausedtheskyrocketingdebtservicecosts.

WhiletheGovernorofIllinoishascalledforauthorizinglegislationtoallowChicago
PublicSchoolstodeclarebankruptcy,suchlegislationisnotinplace.The
overwhelmingDemocraticcontrolofthestateslegislaturemakesthelikelihoodof
impairmentasaresultofbankruptcyanearimpossibility.Additionally,misseddebt
paymentsarealsohighlyunlikelygiventhatChicagohasunlimitedsovereignability
toraisepropertytaxes,andthatChicagohomeowners...payfarlessinproperty
taxesthanthevastmajorityoftheirsuburbanneighbors,accordingtotheChicago
Tribune.24Chicagosabilitytoraisepropertytaxesdistinguishesitfromthe
hundredsoflocalitiessubjecttoataxcap,whichincludecities,counties,andschool
districtsinCalifornia,Massachusetts,NewYork,Oregon,Colorado,andmany
municipalitiesoutsideofChicagoinIllinois.25

AsnotedabovewiththeWellsFargoexample,theratingdowngradedidnothappen
inavacuum.Butsomeoftheforceswerenotablyforwardabouttheirintentions.In
a2013speech,theheadoftheCivicCommitteeoftheCommercialClubof

22
CNBC Berkshire Hathaway Portfolio Tracker. Data pulled May 8, 2017.
23
In a recent study, researchers from Rutgers and Emory found that Moodys gave statistically significant
higher ratings to companies owned or invested in by Berkshire Hathaway, including to Wells Fargo. See:
Does it matter who owns Moodys? Simi Kedia, Shivaram Rajgopal and Xing Zhou. March 23, 2015.
24
Even with Emanuel hike, city homeowner property tax rates still below suburbs. Hal Dardick, Chicago
Tribune. November 13, 2015.
25
Tax Caps in Other States: Lessons for New York. Hector Chang and Christine Wen. Creative
Responses to Fiscal Stress Project, Cornell University. December 2014.
9
Chicago--theroundtableofthecitysbusinesselite--admittedthatsomeofhis
membershadcontactedtheratingsagenciesandurgedthemtolowerratingsasa
waytopressurethestatetodealwithpensioncosts,callingtheratingsagencies
enablers.26Afterthatspeech,ratingsdowngradeshavebeenubiquitousfor
ChicagoandChicagoPublicSchools.

Newark,NewJersey
Totallossestounfairratings:$10millionannually

ShadowyWallStreetactorsspentmillionstoattackincumbentMayorRasBarakain
thecontentious2014election.27Lessthanayearlater,Moodysannouncedaratings
actionthatwouldsendmillionsofdollarsoutthedoortoWallStreet.OnMay15,
2015,Moodysloweredtheratingfor$374millionofNewarksgeneralobligation
debttoBaa3,justonenotchintoinvestmentgrade.Theratingsdowngradewillcost
thecity$10millionannuallyinadditionaldebtservicecostsrelativetoAaadebt.28
Thatexceedsthetotalthecityspendsonhealthcarefortheindigent,environmental
health,andeconomicandhousingdevelopmentbyover$3millionannually.

MoodyshadalsodowngradedNewarktheyearbefore,toBaa1.Inpartdueto
Moodysactions,MayorBarakarequestedstateaid,whichinturnforcedthecityto
submititsbudgetforapprovaltoastateboard,whichforcedtheMayortotakemore
outofpublicemployeespaychecksfortheirhealthcare.Thestateboardsreview
processwaspraisedbyMoodys,butdidnotleadtoanupgrade.Instead,itledtoa
raretwo-notchdowngradethefollowingMay.

Theratingsagencyopenlyadmitsthatthecityshighpovertylevelsfactoredintoits
rating:anopen-shutdefinitionofredlining,inflictedonpeopleonthereceivingend
ofWallStreet-driveneconomicinequality.

Giventhatpovertylevelshavenocorrelationwithdefaultinstateswithoutahistory
ofmunicipaldefaultsorbankruptcy,whattheratingrevealsisinsteadataxon
poverty,ataxonhistoricallymarginalizedpopulations.

26
Chicago CEO Club, With Rahm and Pritzkers on Board, Pushed for Chicago Bond Downgrade,
Whacking Local Investors and Pension-Holders. Yves Smith, Naked Capitalism. July 26, 2013.
27
Newark mayors race: pro-Jeffries independent expenditure group shows donations of $1.3 million,
Wall Street ties in ELEC report. Mark Bonamo, Observer. April 21, 2014.
28
Based on a 2.7% estimated annual spread. The 20-year Moodys AAA index returned 3.35% as of
March 23, 2017, and a 20-year index of New Jersey Baa3 bonds returned 6.05%, again according to
Bloomberg Terminal research. Given that some lower interest rates from when the city was rated higher
are locked in, this is an estimate of future losses if the current rating persists.
10
NoNewJerseycityhasdefaultedonitsdebtsinceWorldWarII,andgiventhe
statesexpansiveroleinmunicipaloversight,itisextremelyunlikelythatanywill
doso,unlesscompelledbythestate.29

CityofJackson,Mississippi
Totallossestounfairratings:$2.8millionannually

InJackson,Mississippi,theapproximatespreadbetweenthecosttoservicedebtat
Aaa--aratingthataccuratelyreflectsJacksonsextendedcredithistoryandthelack
ofstatebankruptcylaw--andthecurrentratings,atBaa2forJacksons$124million
ingeneralobligationdebtandA3forits$228millioninwaterandsewerdebt--are
significant.ThetotalcosttoJacksonforsubparratingsonanannualbasisis
estimatedtocostthecityapproximately$1.6millioninadditionaldebtservicecosts
onthewater/sewerdebt,andapproximately$1.2millioninadditionaldebtservice
costsannuallyongeneralobligationdebt,foratotalof$2.8millionannuallyin
surplusdebtservicecosts.30

Jacksonhasnothadamunicipaldefaultsince1933,andtherearenoprovisionsfor
municipalbankruptcyinMississippi.Moodysnotesthatthegeneralobligationdebt
issecuredbyanannualadvaloremtax,leviedagainstalltaxablepropertyinthecitywithoutlegal
limitationastorateoramount.Inthecaseofthewater/sewerdebt,thebondsaresecuredbythe
system'snetrevenues.31

WhileJacksonhasseendepletioninitsreserves,thequestionisifthatleadsto
default.AndJacksonfacesenormousneeds.Anextra$2.8millionannuallyoutof
Jacksonisnotsomethingthatthecitycanafford.Thecitydesperatelyneeds
substantialimprovementstoitsinfrastructure,andtherehasbeenrampant
austerityoverthepastfewyears,includingfurloughstocityemployees.

Moodystwo-tierratingsystem--onefortheprivatesector,theotherforthepublic
sector--hastheresultofdemandingausterityoutofthosemunicipalitiesthatcan
leastaffordit.
29
For more, see STRICT FISCAL OVERSIGHT KEEPS NEW JERSEY CITIES OUT OF BANKRUPTCY
Mark Magyar, NJ Spotlight. July 22, 2013.
30
Data pulled from a Bloomberg Terminal as of March 23, 2017. General obligation calculations are
based on a 0.98% spread between the cost of Aaa municipal bonds and Baa3 municipal bonds. While
there are not indices that track Baa2 municipal bonds specifically, the difference between the Moodys 20
year Aaa bond index and the Moodys 20 year Baa average was 0.98%. There are three Baa notches,
Baa1, Baa2, and Baa3 (the lowest. Hence the estimate at $1.2 million for GO debt. The water/sewer debt
was based on a 0.7% spread. The difference between the Moodys Aaa and Moodys A 20 year indices
was 0.62%, but A3 is the lowest notch of A debt, thus a 0.7% estimate. Given that some lower interest
rates from when the city was rated higher are locked in, this is an estimate of future losses if the current
rating persists.
31
The revenues, that is, from a system that every resident and business in the City of Jackson--and many
outside--depend on a daily basis.
11

MoreofaDrain

Alltheentitiesidentifiedinthisreporthaveabove-averagecompositionsofpeople
ofcolor.NewJerseyisoneofthemostdiversestates.JacksonandNewarkareboth
majority-black,whilethechildrenservedbyChicagoPublicSchoolsarejust10%
white.

Thisisnotanaccident.Itsworthrecallingaraciallycodedwelfarequeen
statementaboutDetroitfromBrentonW.Harries,aformerPresidentandchief
executiveofStandardandPoorsina1993interview.Harriesarguedthat
[Detroits]particularmixofpopulationrequiresmorewelfarepayments,more
housing.Theyremoreofadrainasopposedtobeingmoreacontributor.32

Harriesfailedtonotethatfundingforwelfareandhousingoverwhelminglycomes
fromfederalandstategovernments,whichlimitstheimportofthatdatatowardsan
assessmentofacityslikelihoodofdefault.ThesameistruewithMoodysdecisions
toincludepovertyandmedianhouseholdincomeinitsratingsmethodologyfor
publicsectordebt.MoodysmakesnoclaimofacorrelationbetweenlowMHIanda
likelihoodtodefault.Butitsintheratingsmethodologyanyways.Itsa21stcentury
formofredlining:youhavetoomanypoorpeople,soyoumustpaymoretoWall
Street.Thefactthatthesecitiesaredisproportionatelypeopleofcolor,and
disproportionatelybearthebruntofaratingssystemgonehaywire,isincidental,
accordingtoMoodys,S&P,andFitch.

Butthepublicknowsbetter.Theratingsagenciesmisconductintheleaduptothe
financialcrisiswastoogreattoexcusemisconductandracismasasourceoftheir
decision-makingwhenitcomestopublicsectorratings.

RedliningwasexplicitlybannedbyCongressin1968viatheFairHousingAct,sotoo
wascreditdiscriminationbytheEqualCreditOpportunityActin1975.Foravariety
ofreasons,theselawshaveneverbeenappliedtotheratingsagencies.Butthis
shouldchange.Giventhelimitedspaceofstatesandmunicipalitieswithsubpar
ratings,thefactthatalmostallofthemarecitieswithhighpopulationsofpeopleof
colorsuggestaclearcaseofraciallydiscriminatorypolicies.33

32
From Debt, Governmentality, and the Neoliberal City. Christopher Foerster-Smith, April 2015.
Additionally, its worth noting that in retrospect, the Detroit Free Press rated then-Mayor Coleman Youngs
stewardship of the citys finances as excellent, finding that Young consistently worked to keep deficits
down. For more, see How Detroit went broke: The answers may surprise you and don't blame
Coleman Young. Nathan Bomey and John Gallagher, Detroit Free Press. September 15, 2013.
33
For more on this subject, see Municipal Bond Ratings and Citizens Rights. John Yinger, American
Economic Law Review. October 20, 2009.
12

ArePensionObligationsAReliableIndicatorofFiscalStress?

Athreadrunningthroughoutthisreportisthattheratingsagencieshavetargeted
municipalitiesforavarietyofreasons,amongthempensionandretireehealthcare
funding.

Thisisanewendeavor.Onlyin2013didMoodysformallyincludepensionfunding
intheirratingsmethodologyforthepublicsector.34Andintherationaleforthe
ratingschange,Moodysmakesnoclaimastotheactualimportofthedatatothe
likelihoodofadefault.Instead,Moodyspresentsitschangesinacircularmanner:
risingpensionobligationshaddrivenMoodysowndebtdowngrades,soithasnow
decidedtoformallyincludethepensiondata,aspresentedbyMoodys,initsformal
analysis.Andratherthanusingadiscountratetoassesspensionobligationsthat
reflectsindustrystandards(around6.5%to7.5%assumedrateofreturn)--Moodys
insteadusedthesignificantly-lower5-yearcorporatebondrate(around3%)to
assessliabilities.

TheeffectofMoodysnumbers-playisasignificantinflationofthecostofpension
obligations.35Theresultismasshysteriaaroundpensionobligations.36

Coincidentally,theformaladditionofpensionfundingissuescameasEnron
billionaireJohnArnoldlaunchedhisnationwideassaultondefined-benefit
pensions.37In2012,Arnoldgranted$5million38tothePewResearchCenterstofund
anadvancedresearchandcommunicationsstrategythatemphasizedthe
unsustainabilityofdefined-benefitpensions--andbyimplicationmakingthecase
fortransitionsto401(k)-styleplansthatofferfarlesscomprehensivebenefitsat
retirement.PriortotheArnoldgranttoPew,publicpensionobligationshada
limitedpresenceinthenationaldiscourse.Sincethegrant,newsarticleshavebeen
writtenacrossthecountrymakingthecasethatpensionbenefitsareunsustainable.

MoodysactionshappenedtoperfectlycoincidewiththeArnold-financeduptickin
concernaboutpensionobligations.AndMoodyshasalsonothesitatedtointervene
instate-levelbattlesoverpensionreform,arguingthattheIllinoisSupremeCourts

34
Adjustments to US State and Local Government Reported Pension Data. Moodys Investor Service
Cross Sector Ratings Methodology. 2013. And Announcement: Moody's announces new approach to
analyzing state, local government pensions; 29 local governments placed under review. Press Release.
April 17, 2013.
35
Moodys flawed estimate on public pension liabilities. Cate Long, Reuters. June 28, 2013.
36
For more, see The real threat to pensions is Wall Street. Matthew Cunningham-Cook, Al Jazeera
America. December 11, 2014.
37
For more, see The Plot Against Pensions. David Sirota, Institute for Americas Future. September
2013.
38
John Arnold: The Most Hated Man in Pensionland. Liz Farmer, Governing. April 2017.
13
rejectionofpensioncutswascreditnegativeinJuly2014,39warningthataNew
JerseySupremeCourtdecisioninfavorofworkersdemandingtheircontractually
andconstitutionally-mandatedcostoflivingadjustmentswouldnegativelyaffect
[NewJerseys]creditprofile.40WhileMoodyshasalsointervenedinsomecases
overtaxes,ithasbeenfarmoretaciturntopunishcitiesandstatesforafailureto
taxthanforafailuretoaddresspensionobligations.41Indeed,despiterampant
evidenceofoutofcontrolinterest-rateswappayments--manyofwhichare
unnecessary,givenawillingnessonthepartofbankstonegotiatewhenthreatened
withlegalaction--Moodyshasneverspokenup.

Thesamegoeswithcorporatesubsidies.Therewassilencefromtheratingsagencies
whenTheRecordfoundthatcorporatesubsidiesunderGovernorChristiehad
explodedto$7.4billionfrom2010to201642--despitethefactthatunlikethe
pensioncostoflivingadjustmentsatissueinthecourtcase,corporatesubsidiesare
notanearnedcontractualobligation.

NextSteps

Thegoalofthisreportistodemonstratethattheratingsagencies1)applytwo
differentstandardsforpublicandprivatesectordebt,costingcities,statesand
schooldistrictsmillions,2)engageinredlining-typepracticesthat
disproportionatelyaffectcommunitiesofcolor,and3)haveincludedpension
obligationsintheirratinganalysiswithnoevidencethatsuchobligationsincrease
thelikelihoodtodefault.

GiventhattheirexistenceispredicatedontheNRSROauthorizationfromtheSEC,
creditratingagencieshaveapublicinterestobligationtoensurethattheirpolicies
donotdisproportionatelyforcecitiesandstatestopayhigherdebtservicecostsjust
becausetheyarecitiesandstates.

ThisisthereasonwhytheratingsagenciessettledwiththeStateofConnecticut,
andthenMoodysengagedinmassupgradingofpublicsectordebt--savingcities,
counties,statesandschooldistricts$1billionannually.

39
Moody's says court ruling is negative for Illinois pension reform. Reuters, July 11, 2014.
40
Moody's: Pension case poses risk for N.J.'s credit rating. Andrew Seidman, Philly.com. January 21,
2016.
41
See Kansas credit rating of Aa2--two notches below Aaa, compared to A2 for New Jersey, six notches
below Aaa, and Baa2 for the Illinois, eight notches below Aaa. For more on Kansas fiscal difficulties, see
What Trump Can Learn From Kansas Tax Troubles. Kyle Pomerlau, Scott Drenkard, and John Buhl,
Politico. May 4, 2017.
42
Lawmakers ignoring $7.4B boom in 'corporate welfare,' experts say. Salvador Rizzo,
NorthJersey.com. December 18, 2016.
14
Andadoublestandardforpublicsectorissuersisalsoillegal.Dodd-Frankmandated
auniversalstandard.Thisreportmakesitclearthatthatmandatehasnotbeen
reached.

WithaformerGoldmanSachsattorneynowleadingtheSEC,changefromthe
federalgovernmentisnotlikely.Cities,counties,andstateattorneysgeneralmust
followConnecticutsleadandtakeactionagainsttheratingsagenciestoholdthem
accountableforthegrossfinancialinjusticesdescribedhere.

Acknowledgments
TheauthorofthisreportreservesthedeepestthankstoMarcJoffeforhisinsight
intothisissue.AdditionalthanksgotoSaqibBhatti,CarrieSloan,BrooksSunkett,
MelissaMatos,theServiceEmployeesInternationalUnion,andBillHarrington.43
ThisreportwaspublishedwiththesupportoftheCommunicationsWorkersof
AmericaDepartmentofPublic,HealthcareandEducationWorkers.

Methodologies
Theestimatesinthisreportoflossesduetounfairratingscomefromestimatesof
spreadsbetweenbondsdependingontheircreditrating,pulledfromaBloomberg
TerminalonMarch23,2017.Thespreadwasthenpluggedintotheamountofdebt
affected,accordingtoMoodys.Giventhatsomelowerinterestratesfromwhenthe
statewasratedhigherarelockedin,thisisanestimateoffuturelossesifthe
currentratingpersists.

NoteonPuertoRico

ThelargestmunicipaldebtcrisisinthecountryrightnowisinPuertoRico,where
theactionsoftheratingsagencieshavenotbeenhelpful--bothintheleaduptothe
crisistonow.However,theislandsspeciallegalstatussignificantlydifferentiatesit
fromtherestofthebondmarketandassuchIdidnotincludeitinthereport.There
areotheraspectsthatdifferentiatethesituationinPuertoRicoaswell.Formoreon
this,seepleaseseetheReFundAmericaProjectsseriesonPuertoRicosdebt.

43
Of course, acknowledgments do not imply the full endorsement of this report by the acknowledged.
15