Reading risk: The practices,limits and politics of municipal bond rating

Abstract

This article contributes to the growing literature on the relationship between local governments and financial markets by demystifying the municipal bond rating process. Since the Great Recession, the dynamics of municipal debt have moved to the forefront of American urban politics and the pursuit of high bond ratings has become a key mechanism constraining local policy autonomy. However, we know little about the actual practices of the rating agencies. Drawing on interviews conducted within these organizations, the article examines the criteria, processes and organizational practices that produce ratings. In conversation with calls for bridging the divide between political economy and techno-cultural approaches to markets, the paper shows how bond rating is structured by an ever-present tension between the need to understand localized investment risk in all its place-specific complexity while striving to fit that risk within the standardized grid of the rating scale. Further, the analysis highlights the imperative of budget flexibility through which indebted local governments are pushed into self-disciplining of their finances. As such, the article unpacks a particularly opaque area of local politics and furthers ongoing conversations between financial geography and urban political economy.

Keywords

Credit rating agencies municipal debt bond markets urban financialization

Introduction

Writing about the encroachment of finance in American urban governance, Peck and Whiteside (2016) recently made a call for closer engagement between urban political economy and financial geography. As such they contributed to an emerging field of urban scholarship scrutinizing the new relationship between local governments and financial markets, arguing that American urban governance has become financialized as speculative schemes expose cities to intensified financial risks and debtor discipline (Kirkpatrick, 2016; Kirkpatrick and Smith, 2011; Pacewicz, 2013; Weber, 2010). In this context, urban politics has become submitted to the judgments of extra-local financial actors and institutions. Chief among these stand the credit rating agencies which, according to Hackworth (2007), have become increasingly important to please in a context of rollback of inter-governmental fiscal transfers, the rise of large institutional investors and processes of financial disintermediation. As Biles (2018: 1099) writes, “sensitive to the expectations and values of Wall Street institutions and desperate to acquire or maintain high ratings, cities have tailored their policies accordingly.” These firms, principally Moody’s Investors Service (Moody’s), Standard & Poor’s Financial Services (S&P) and Fitch Ratings (Fitch), judge the likelihood that borrowers will default on their debt by rating them on a scale ranging from AAA to D (see Table 1). Lower ratings lead to higher borrowing costs and urban political economists have explored the effects of this imperative on local politics.

Table 1.

The rating scale (adapted from Fitch, 2017; Moody’s, 2017; S&P, 2016).

Moody’s	Standard & Poor’s	Fitch
Prime
Aaa	AAA	AAA
Aa1	AA+	AA+
Aa2	AA	AA
Aa3	AA−	AA−
A1	A+	A+
A2	A	A
A3	A−	A−
Baa1	BBB+	BBB+
Baa2	BBB	BBB
Baa3	BBB−	BBB−
Speculative
Ba1	BB+	BB+
Ba2	BB	BB−
Ba3	BB−	B+
B1	B+	B
B2	B	B−
B3	B−	CCC
Caa1	CCC+	CC
Caa2	CCC	C
Caa3	CCC−	RD/D
Ca	CC	/
C	C	/
/	D	/

In these accounts, the rating agencies are critiqued for holding local administrations “hostage” in a never-ending search for creditworthiness with detrimental consequences for local democracy and service provision (Ross, 2017: 25), but despite frequent invocations of their power we know little about how the agencies make their judgments. Indeed, with an emphasis on localized effects, the actual practices of bond rating have been overlooked. Responding to recent calls for political economists to more fully engage with the micro-politics of markets (Braun, 2016; Christophers, 2014; Fields, 2018), the paper examines this blind spot. Seeking to overcome a “bifurcation” between political economists concerned with capitalist restructuring writ large and “techno-cultural” approaches to market-making inspired by Science & Technology Studies (Christophers, 2014: 12), these calls have emphasized the mutually beneficial nature of an encounter in which the former’s critique of power can be combined with the detailed examination of situated practices that characterize the latter (Fields, 2018). In particular, Braun (2016: 258) argues that, while political economists often hold a narrow conceptualization of politics, the “‘micro-institutions of capitalism’ … matter for political economy, not only as participants or objects of political struggles over (de)regulation, but as sites of politics in their own right.”

Following this argument, the paper examines bond rating as a politicized micro-institution, as central “market devices” contributing to the “calculative agency” that is crucial for financial markets to function (Callon and Muniesa, 2005). While this literature is wide-ranging, the paper specifically draws on critical accounts of commensuration to explore how rating agencies establish a common metric against which heterogeneous financial uncertainties can be evaluated and traded (Espeland and Stevens, 1998). In this sense, the agencies “play a crucial role in constructing markets” for a range of financial asset classes (Sinclair, 2005: 15): from Residential Mortgage-Backed Securities and Collateral Debt Obligations in the lead-up to the subprime mortgage crisis (MacKenzie, 2011) to single-family rentals in its aftermath (Fields, 2018). However, if urban political economy has emphasized the political effects of bond rating while overlooking its internal practices, the relatively mundane municipal sector has conversely received little attention within the techno-cultural literature (Besedovsky, 2017; MacKenzie, 2011; Paudyn, 2014). This paper seeks to bridge these two approaches by drawing on in-depth interviews with municipal finance professionals and close reading of rating methodologies, providing a window into a particularly opaque area of urban politics.

The next section situates the significance of bond rating in the changing landscape of US municipal finance whose increasingly speculative character has come under greater scrutiny from investors and rating agencies. Thereafter, the article draws on critical work on commensuration to highlight a central tension structuring the bond rating process between understanding default risks in all their place-specific complexity while inevitably having to fit this local milieu within the standardized grid of the rating scale. Turning towards how this is achieved, the major empirical section proceeds in three steps to interrogate the practices, limits and politics of the rating process. Firstly, it tracks the interacting moments of breaking apart followed by reassembly through which a bond rating is made. Secondly, it examines the regulatory push toward rating standardization after the subprime mortgage crisis as a moment where the limits of this process become particularly visible, highlighting the continuing struggle to consistently apply uniform rating criteria to diverse local governments. Thirdly, it identifies the contested politics of bond rating, found within the seemingly technical measure of “budget flexibility” with regard to debt repayment – that is, the ability of local governments to curb competing fiscal demands to ensure repayment of bonds and other financial commitments. A conclusion, finally, summarizes the argument.

The political economy of municipal bonds

In 1968, Roy M. Goodman, Finance Administrator of New York City, appeared before the US Congress to give testimony on the economic effects of bond rating, performed by agencies that had “assumed almost biblical authority throughout the American investing economy” (Goodman, 1968: 60). Criticizing their “inadequate fact gathering,” he lamented a recent “rating fiasco:” Moody’s downgrade of New York from A to Baa, leading to additional interest costs of $20 million on each bond issue (Goodman, 1968: 61). As Poon (2012: 12, emphasis in original) points out, this testimony illustrates how with bond rating “the government has been confronted by an ambitious financial logic … which was being propagated by the very instrument it elevated into a handmaiden of domestic legal administration.” That is, while the influence of rating agencies is predicated on their use in financial regulation,¹ they have assumed greater powers over governments themselves. This section will introduce municipal bonds and show how, as municipal finance has become more speculative, cities are increasingly exposed to bond rating scrutiny.

The “regime of financial control” represented by bond rating (Poon, 2012: 12) becomes particularly visible at moments of fiscal crisis, such as the subordination of Goodman’s city to the overriding authority of New York State’s Financial Control Board in 1975 (Phillips-Fein, 2017). In the wake of the 2007–2008 subprime mortgage crisis, the attendant pressures and imperatives have once again moved to the forefront of politics. Explored in terms of “austerity urbanism,” this has been described as a doubling down of neoliberalization and a return of the “urban fiscal crisis” (Peck, 2012). But, while Goodman might recognize the contemporary politics of austerity and financial control, Kirkpatrick (2016: 26) cautions against interpreting these crises through the same conceptual frame, arguing that “conventional explanations of urban fiscal crisis only go so far in explaining contemporary cases, a limitation traced to the changing role of financial markets in urban affairs.” Crucially, austerity urbanism, while reenacting familiar neoliberal tropes, is playing out in a context where urban affairs have become financialized as local governments have engaged more speculative financial instruments, making their fiscal operations increasingly unstable (Kirkpatrick, 2016). Under this rubric, urban political economists have interrogated the proliferation of financial innovations across American cities (Davidson and Ward, 2014; Pacewicz, 2013; Weber, 2010) and emphasized the increasing prominence of debt dynamics as drivers of local politics (Kirkpatrick and Smith, 2011; Peck and Whiteside, 2016). This requires closer attention to the municipal bond market.

Municipal bonds are financial instruments issued by US subnational governments to fund long-term capital needs and sold to investors seeking a secure, often tax-exempt, income. Because governments rarely default, their bonds were long considered a particularly safe asset and few scholars, Sbragia (1996) being the rare exception, paid much attention. What traditionally makes municipal bonds different from other financial securities is a federal tax exemption on interest income. This allows issuing governments to borrow more affordably because investors, who do not need to compensate for net-income shortfalls due to taxation, are able to accept lower interest rates. Individual municipal bonds are classified in accordance with the sources of government revenue that are pledged as security for borrowing, primarily as either General Obligation bonds (GOs), which pledge the municipality’s entire taxing power, or revenue bonds, which pledge only a particular revenue stream. Unlike GOs, which are issued by general-purpose governments principally for the financing of publicly accessible infrastructures like streets and sewers, revenue bonds are issued, often by “special authorities,” for self-sufficient and revenue-generating infrastructures like water and utility networks.

Revenue bonds are not considered an obligation on the balance sheet of the general-purpose government and have in this capacity been central to the “politics of circumvention” that, according to Sbragia (1996: 5, 104), has characterized the development of municipal finance throughout the 20th century where innovations to circumvent borrowing restrictions and bond rating discipline have “changed the very meaning of the term municipal government, changed its structure and helped change the kinds of public service that entered the public domain.” In particular, with the post-Keynesian rollback of intergovernmental fiscal transfers and the rollout of more “entrepreneurial” urban development strategies (Harvey, 1989; Leitner, 1990), the value of US municipal bonds has exploded from a mere US$400 billion in 1980 to US$3.8 trillion in 2016 (SIFMA, 2017). 59% of this market is now made up by revenue bonds, often issued by non-elected governmental units such as redevelopment agencies, toll-road authorities, or water and sewage departments (SIFMA, 2017). This has produced a form of “speculative urbanism” as cities come to “speculate on future economic growth by borrowing against predicted future revenue streams to make this growth likely” (Davidson and Ward, 2014: 84). However, investors have come to doubt the safety of the market because “[w]hen cities accept the risks associated with financialized policy instruments, their ability to stay solvent and fund basic government operations … are potentially compromised” (Weber, 2010: 260).

The increasing use of more speculative municipal financial instruments to fund not just basic infrastructures but speculative economic development projects have, then, exposed cities to the risks that these projects might never materialize, leaving municipalities footing bills far beyond their capacity (Kirkpatrick, 2016). As a result of this shift, fueled by the rollback of intergovernmental fiscal transfers and the development of more sophisticated financial instruments, investors and rating agencies are more cautious of an investment class that long appeared particularly safe. The repercussions of this on cities have become especially acute in the aftermath of the subprime crisis. Here, while municipalities briefly benefited from federal stimulus policies² and also received greater regulatory protection (Doty, 2012), a dramatic increase in municipal bankruptcy filings has meant that they now operate in an even more differentiated credit market while being put under increasing scrutiny from rating agencies and investors.

Indeed, municipal bankruptcy used to be a rare occurrence, with only 645 municipal bankruptcy filings since 1937 compared with 10–11,000 corporate equivalents (Comes et al., 2015: 157). Between 2008 and 2015, however, 15 local governments petitioned judges to allow them to restructure their obligations (Governing, 2015), provoking concern among market actors that the fundamental “rules of the game” had changed (Comes et al., 2015: 146). While bankruptcy may represent a temporary break of financial control over individual municipalities, the effects of these localized cases resonate throughout the market, exposing other cities to ever greater degrees of market scrutiny in the form of more thorough analysis of their underlying credit quality by investors and rating agencies alike (Wolfe and Chief Investment Officer Team, 2013). This makes it increasingly important to understand municipal bond rating, not just as an object of regulatory politics, but as a site of politics in its own right. That is the purpose of the rest of this paper, with the next section positioning the rating agencies within financial markets.

“You can’t even compare city to city:” bond rating as commensuration

From being a sleepy financial backwater for risk-averse investors, municipal bonds have morphed into an increasingly complex and fragmented market of over one million individual bond issues (SEC, 2012: 5) on behalf of around 50,000 government units in 40 different subsectors of public finance (Comes et al., 2015: 41). Indeed, market analysts argue that “munis” have become “a large, diverse, complex marketplace comprising an extremely large number of issues with relatively low market value” (De Groot et al., 2010: 3) so that “in fact it is not really a single market at all, but a combination of different regional markets with thousands of issuers” (Wolfe and Chief Investment Officer Team, 2013: 1). Further, since each municipal bond is distinct in terms of its structure, underlying security and trading patterns, even experienced analysts point to the difficulties of generalizing about the market as a whole. As one former rating analyst reflects:

Muni finance is so complicated because all of these different issuers are just lumped together because of the tax exemption, but you have different state laws, you have different security structures, different types of issuers. What means something in one state doesn't mean the same thing in another so it's very complex … Then, you know, what powers do certain types of entities have? For example, New York City handles its school district, Chicago has a separate entity. So, you can’t even compare city to city because they have different services that they are providing even at like levels of government (former rating analyst #2, 2016, emphasis added).

This analyst insists that “you can’t even compare city to city,” but that is what bond rating is all about: placing a diversity of cities onto a single rating scale that allows investors to compare investment opportunities. Here, bond rating provides a form of commensuration enabling the comparison of heterogeneous entities against a common metric (Espeland and Stevens, 1998).

The mainstream view on credit rating holds that it is a natural outgrowth of markets striving toward efficiency, initially developing to supply distant financiers with localized credit information during the 19th-century development of the American railroad (Sylla, 2002). A less economistic argument has been elaborated by Sinclair (2005) with regard to the dramatic expansion of the credit rating business in the context of globalization and financial market “disintermediation.” Because banks are no longer the principal suppliers of credit, these markets call for new infrastructures for evaluating investment risk and “ratings increasingly become the norm as capital markets have displaced bank lending and as the trust implicit in these older systems has broken down” (Sinclair, 2005: 5). Under these conditions, rating agencies as “embedded knowledge networks” assume the role of legitimate organizers of credit information (Sinclair, 2005: 15). However, in the wake of their involvement in the subprime mortgage crisis (when the agencies initially seemed oblivious to the risks of financial engineering only to subsequently react with sharp downgrades), a deep distrust toward the accuracy of ratings has taken hold (Sinclair, 2010). This is true among both investors and regulators, the latter removing many requirements of relying on ratings as part of financial regulations (Kruck, 2011).

In the face of such a crisis of legitimacy, we can draw inspiration from critical scholars of commensuration to understand the role that rating agencies play in markets that increasingly distrust them. These authors argue that commensuration, or “the expression or measurement of characteristics normally represented by different units according to a common metric,” is a central (albeit often invisible) aspect of modern social life (Espeland and Stevens, 1998: 315). Creating relationships between things that previously seemed unrelated, commensuration transforms qualities into quantities in a processes that simultaneously unites objects by incorporating them within the same frame of reference and differentiates those same objects by assigning them different quantities of that which makes them comparable; be it the price of commodities, the ranking of universities, or the value of ecosystems (Espeland and Stevens, 2008). It is, in the words of Kockelman (2006: 96), “a process whereby otherwise distinct entities are rendered comparable by reference to proportional quantities of a shared quality.” Substantively, then, commensuration involves the identification and measurement of a mutual essence whereby seemingly incommensurable entities can be compared.

Central to commensuration as a “mechanism of sensemaking” is simplification of information and decontextualization of knowledge so as to allow for its wider circulation, but in this respect commensuration continually encounters limits (Espeland and Sauder, 2007: 17). These include limits to subsuming complexity under the common metric, but also moral claims to incommensurability. As a consequence, any commensuration process will be deeply contradictory and highly politicized. Far from unproblematic, critical scholars of commensuration argue that:

[i]nvestigating commensuration is important because it is ubiquitous and demands vast resources, discipline, and organization. Commensuration can radically transform the world by creating new social categories and backing them with the weight of powerful institutions. Commensuration is political: It re-constructs relations of authority, creates new political entities, and establishes new interpretive framework. Despite some advocates’ claims, it is not a neutral or merely technical process (Espeland and Stevens, 1998: 323).

In particular, processes of commensuration are deeply structured by what Mann (2018: 196) describes as the “fundamental and inescapable dialectic” of capitalist adequation: they must simultaneously preserve the specificities of their inputs and cancel them out. This is to say that a successful commensuration process, while reducing particularities to a common metric, nevertheless has to continually negotiate a careful balance between universality and specificity, or else it risks appearing as entirely illegitimate in the face of readily observable difference. In this sense, “making things the same” (MacKenzie, 2009: 440) involves hard work and contested politics, both of which become obscured when relations of commensurability appear as natural and unproblematic.

The central importance of commensuration in financial markets can be best comprehended by reflecting on the nature of these markets as spaces in which commodities are exchanged. They are, as Henwood (1998: 22) reminds us, sites in which “debts, mere promises to pay, are … transformed into commodities in the eyes of creditors.” These commodities (financial securities) are at a certain level incommensurable. Like cities, the underlying assets to which they refer can seem impossible to compare. Nevertheless, such comparisons are continually made in daily financial trading. Here, the key mutual essence, the “proportional quantities of a shared quality” that allows for comparability (Kockelman, 2006), is that of investment risk. This is to say that, since the peculiar nature of a commodified debt means that there is no guaranteed “consumption,” no certainty that the promise of payment will stand, financial securities are risk-bearing commodities, priced in relation to how (un)likely it is that investors will recoup the money they have put forward. The commensuration process involved when trading these are, then, the untangling of the investment risk of each security from its concrete specificity to make it comparable across difference. Indeed, “[t]he future uncertainty priced as risk by financial instruments comes … in myriad shapes and forms. Liquid trade in such instruments and the commodified financial risk they constitute is only possible if such uniqueness is successfully abstracted from to produce commensurability” (Christophers, 2018: 336). The reality of financial trade is, one of continual abstraction and commensuration of diverse investment risks so as to adequately price and trade financial securities.

This approach allows for a more critical understanding of credit ratings. In particular, while much debate over the merits of the rating agencies circulate around their failures to accurately predict defaults (e.g., Financial Stability Forum, 2008; SEC, 2008), an analysis of commensuration helps us break out of this problematic. This is the case because, rather than assuming that an exact measure of default risk can be known (and that the rating agencies simply fail in this task), a focus on commensurations highlights the fundamentally relative nature of credit rating by emphasizing how the individual judgment of creditworthiness (investment risk) has little value on its own. Indeed, ratings are not cardinal measures of risk but ordinal ones: it is the relative rating of one credit vis-à-vis all other credits that matters (Kruck, 2011). In this sense, instead of supplying simply a prediction of default, credit rating is primarily a form of commensuration that allows credits to “be ordered (from most to least creditworthy), categorized, labeled and counted” (Carruthers, 2013: 527; Paudyn, 2014).

In the relatively secure municipal bond market, this need to “authorize the commensurability of different regimes of contingency within the domain of financial exchange” (Johnson, 2013: 31) appears almost as important as the default prediction itself. As argued by a former rating analyst:

We are lucky in our industry because we have so few defaults, so how do you know if you're wrong? You are really calibrating to a very narrow, infrequent event so all those fine gradations and trying to rate credit make a difference, but at end of the day it only makes a difference in terms of relative value because otherwise you would say that everything is pretty much AA or AAA because it doesn’t default (former rating analyst #2, 2016, emphasis added).

In particular, as another former rating analyst points out, credit ratings function as the only “publicly shared credit information” on which buyers and sellers can agree (former rating analyst #3, 2016). Like other financial indicators (such as LIBOR, an interest rate index used in a wide range of financial contracts), ratings provide a “legal technology of arbitration” around which financial market actors can negotiate price (Ashton and Christophers, 2015: 189). They are not simply passive observers of credit conditions, but “calculative devices of risk” that help make markets (Langley, 2008: 496).

Bond rating is not unique in this regard, but processes of commensuration proliferate throughout (financial) markets. Critical scholars have, for example, interrogated how financial derivatives allow for the transformation of a wide range of social relations and worldly events into singular indicators, instruments and securities allowing for comparison across heterogeneity (LiPuma and Lee, 2004). These accounts have highlighted the complex techniques involved in creating a shared benchmark that can anchor an increasingly globalized financial system, including the commensuration of different financial assets by establishing price relations that both “bind” the present to the future and “blend” different forms of assets (Bryan and Rafferty, 2006). Equally, the importance of commensuration has been highlighted by geographers and urbanists with regard to a range of other markets, including for environmental vulnerabilities (Johnson, 2013), private real estate development (Searle, 2014) and emissions (Cooper, 2015). Building on these insights, the next section will examine the municipal bond rating process.

It’s all in the methodology: rating municipal bonds

Like sovereign debt, municipal bonds are rated in accordance to a “diagnostic” conception of risk that takes on a holistic and case-based approach to analysis, quite in contrast to the “technical” conception of risk reliant on probabilistic modeling that dominates both consumer credit scoring and the rating of structured finance (Besedovsky, 2017). Compared with the formal algorithms of consumer credit scores, therefore, bond rating requires high degrees of qualitative judgment. It resembles an art rather than a science, more reliant on expert judgment than statistical techniques (Ron-Tas and Hiss, 2010). This is particularly true for the municipal market, which one former rating analyst contrasts with corporate bonds by arguing that the latter “is easier because it has fewer issuers and more harmonized financial reporting practices. You can effectively connect an Excel spreadsheet to the Bloomberg terminal and the computer will do 95% of the work for you. Munis don’t have this uniformity and you need a lot more manpower and less computer analysis” (former rating analyst #5, 2016). This is because public finance fundamentally lacks standardization. Rating agencies cannot just “plug in the numbers” since “every state has its own laws, every security has its own little features” (former rating analyst #1, 2016).

On these terms, municipal bond ratings are produced through a deeply social process in which rating analysts are continually forced to negotiate a knife-edge path between commensurability and specificity, quantification and qualitative judgment (Ron-Tas and Hiss, 2010). In particular, the necessary discretion of rating analysts makes municipal bond rating quite distinct from other financial commensuration processes, which to a greater degree have been influenced by the development of structured finance since the 1980s, and the associated rise of probabilistic conceptions of causality and the “quants” tasked with computing these (Besedovsky, 2017). Now, the emphasis when rating many securities is more squarely on financial numbers and less on holistic assessments of a mix of quantitative and qualitative factors. While Besedovsky (2017: 68) argues that this has entailed a paradigm shift in the work practices of the rating agencies, municipal bond rating is still carried out in accordance with a more traditional “case-centered approach, which uses panel data and sometimes quasi-ethnographic methods … highlights the heterogeneity of cases, and relies on expert knowledge to construct and makes sense of casual relations.” There is in municipal finance still a relatively strong role for the individual rating analyst, who develop a deep descriptive knowledge of their asset class but is less able to statistically predict default rates.

This section will in detail examine that process, drawing on research conducted in 2016 aimed at interrogating the relation between rating agencies and local governments in the context of austerity urbanism. Ten semi-structured interviews exploring the practices of bond rating were conducted with rating analysts or former rating analysts, in addition to 12 interviews with financial professionals within the local government system of New Jersey. The interviewees were accessed through a snowball sampling method and were asked to discuss changes in municipal finance, explain the rating process and reflect on its challenges, politics and contradictions. While several of the most candid respondents had recently left the rating agencies, they remained active within the public finance sector (in particular, working as municipal analysts for major banks). This meant they could reflect more openly on what remains a highly controversial business. Complementing these interviews with a close reading of rating methodologies, the next section examines how ratings are made through a process whereby analysts break apart the risk profile of a local government into individual rating factors to be judged on their own terms just to, subsequently, reassemble all these factors into a single indicator of default risk. The way this becomes possible is by relying on clearly specified criteria for evaluating different risk factors while ensuring consistency across space. It is all in the methodology, to paraphrase one analyst (rating analyst #1, 2016).

Practices of bond rating

When the rating process (Figure 1) is initiated, a bond-issuing municipality approaches a rating agency and provides it with the information that will later go into the “official statement” of the bond issue. This document is “a slice-in-time picture showing the essential elements of the agreement and the status of the issuer” (Fischer, 2013: 49–50), including maturity dates, the security for the bond and basic financial information such as budgets and audits, as well as an extensive description of the municipality and its demographics, governance structure, tax collection rates and major employers. As one rating analyst points out, however, the official statement is really a “marketing document” in which the municipality tells its “story” while the work of bond rating is to “think about that story and figure out if that’s the whole story or part of the story and what the other parts of the story might be” (rating analyst #2, 2016). Diving beneath the immediate appearance of a local credit story requires analysts to draw on a broad combination of quantitative and qualitative data, relying on financial accounts, publicly available socioeconomic statistics and internally developed databases alongside conversations with local management in conference calls and site visits (rating analyst #1, 2016).

Figure 1.

The rating process.

These latter occasions are highly staged performances where the rating analysts dig deeper behind the hard numbers, probing questions about debt structure and further plans for issuance of debt while trying to get a feel for the local economy and the financial expertise of management. The description of such visits by one municipal financial officer highlights their subjective and experiential nature:

We take the agencies for a dog and pony show. We take them out for lunch and we go to the mall and to the properties involved there … It's a form of communication, just keeping them informed … They can come over here and see the college and the train station and we show them all redevelopment schemes and the redevelopment financial revenue and say, ‘this is what it's going to be’ so they have a feel of what the city is about, what it's going to look like … It's something you visually can see and see that we're not making anything up … They can see that this is real. When you're driving around for 20 minutes looking for a parking spot then you really know that there is a lot of activity going on, a lot of revenue being generated (CFO, Elizabeth, NJ, 2016).

Municipal officials put high trust in the persuasive power of such visits to busy parking lots and bustling trains stations. Indeed, a former Chief Financial Officer (CFO) of Newark insists that taking the rating analysts on tours of local attractions, such as the Newark Museum or the New Jersey Devils ice hockey stadium, is as important to the rating process as the financial numbers themselves (former CFO, Newark, NJ, 2016). Seasoned rating analysts are, however, well aware of their staged nature, seeking recourse in the “objectivity” of the rating methodology whenever they can (rating analyst #3, 2016).

Asked what the greatest challenge in assigning a “correct” rating is, one senior analyst notes that the challenge is not the individual rating itself, but consistency across ratings. That is, “making sure that if we say that this is a strong revenue framework in Texas that we look at the same thing in Massachusetts. That we're assessing it the same way, making sure that the differences and similarities are accurately reflected … making sure that if this one is AA- that one is also AA- if they're really similar” (rating analyst #2, 2016). Another former analyst emphasizes “consistency, transparency, and accuracy” but quickly adds that while “the rating is supposed to predict whether it’s going to be a default, if you’re assigning ratings without any consistency and transparency what’s the value?” (former rating analyst #7, 2016). The rating methodologies are, therefore, designed to “break things apart and figure out what it is that led you to a certain conclusion [in one place] and why would it lead you to a different conclusion in another place?” (rating analyst #2, 2016). This is a strategy of analytically abstracting from complexities when assessing risk, whereby highly contingent localized combinations of risk factors are disaggregated into more manageable units that are compared against a common metric. The purpose of the rating methodologies is to clearly specify relevant risk factors, breaking them down into smaller subfactors and, sometimes, giving them different weights in accordance with their relative importance.

While each asset class has its own rating methodology, GO-bond ratings are illustrative. These methodologies, first, look at the basic strength of the local economy which provides the taxes that constitute the ultimate basis for debt repayment. As Fitch (2016: 1) argues, the economic base of a municipality “serves as the foundation for the key rating factor assessments that place the credit within and sometimes outside the expected rating range.” Second, local governments need to be able and willing to transform local economic strength into revenues. According to Moody’s (2016: 8), they must “translate economic weight into credit strength.” Factors related to financial performance, therefore, indicate the ability of the municipality to manage its finances in the face of the structural forces affecting its economy. The rating factors themselves are broken down into several subfactors and each gets a score in relation to its relative performance. Table 2 outlines Moody’s rating scorecard with its four rating factors of economy/tax base, finances, management, and debt/pensions; each further broken down into specific subfactors. It is important not to take these factors at face value. As Moody’s (2016: 7, emphasis added) points out, they should rather be understood as “quantitative measures that act as proxies for a variety of different tax base characteristics, financial conditions, and governance behavior that can otherwise be difficult to measure objectively and consistently.” Similarly, while evaluating how a municipality will be able to service its debt in the future, the agencies can only analyze performance based on historical data.

Table 2.

Moody’s “scorecard” for rating local government General Obligation bonds (adapted from Moody’s, 2016).

Rating factor	Factor weight	Subfactor	Subfactor weight
Economy/tax base:	30%	Tax base size (full value)	10%
		Full value/capita	10%
		Wealth (median family income)	10%
Finances:	30%	Fund balance (% of revenue)	10%
		Fund balance Trend (5-year change)	5%
		Cash balance (% of revenues)	10%
		Cash balance trend (5-year change)	5%
Management:	20%	Institutional framework	10%
		Operating history	10%
Debt/pensions:	20%	Debt to full value	5%
		Debt to revenue	5%
		Moody’s-adjusted net pension liability (3-year average) to full value	5%
		Moody’s-adjusted net pension liability (3-year average) to revenue	5%

After breaking apart the risk profile of a municipality into rating factors and subfactors, the final assignment of a rating entails the reassembly of these factors into a single indicator of investment risk. The agencies have different strategies toward this aim. Moody’s (2016) and S&P (2013) choose to weight the factors at set percentages, but Fitch (2016) refuses to do so as it believes the relative importance of different rating factors varies depending on the individual credit. All agencies, however, construct rating profiles of seemingly incommensurable places by combining individually comparable risk factors into unique wholes that can be compared with other unique wholes by virtue of being composed of similar relative risk factors. In this way, bond rating can be understood as a deeply contradictory commensuration process whereby, to facilitate the exchange of municipal bonds, rating analysts must transform ever-contingent local fiscal relations into a measure of “abstract risk;” a term used by LiPuma and Lee (2004: 23) to describe how risk under financialized capitalism has “become abstracted from the relatively concrete uniqueness of uncertainties.”

The process by which the rating agencies decompose the risk profile of municipalities into individual, more manageable indicators is at the heart of the commensuration process. Like critical scholars of financial derivatives have shown, breaking apart complex risk profiles into individually comparably indicators allows the attributes of any asset “to be configured as universally recognizable and generic” (Martin et al., 2008: 126). In the case of municipal debt, it enables the specificities of each city (its fiscal capacity, level of indebtedness and managerial procedures) to be compared against a common metric regardless of its unique position in rounds of uneven development or its particular political contestations and financial history. In this sense, by not directly assessing cities as wholes but rather isolating seemingly “universally recognizable and generic” indicators which are then weighted against each other, the rating process operates to create a veneer of commensurability even in the face of radically incommensurable local dynamics. If “you can’t even compare city to city,” there is a sense among rating analysts that at least you can evaluate their individual financial attributes, and from these “micro-foundations” reconstruct complex aggregates that are nevertheless reducible to the sum of their underlying fundamentals.

In this subsequent reassembly, financial risk is “objectified” through a process that “concretizes a complex amalgamation of social, economic, and political relations into a single recognizable object … that then appears to be independent of these social relations because they are not part of the manifest appearance of the object or instrument” (LiPuma and Lee, 2004: 24). If the decomposition of risk profiles allows the complex social relations of a city to be reduced to more manageable individual indicators, their aggregation effects a further abstraction from these underlying dynamics in favor of the singular object of the rating, which can more easily circulate in financial markets. Here, the individual bond rating acts as a stand-in for contingent localized processes that enables investors to price and trade municipal bonds without having to bother with local socio-spatial relations in their full complexity. Indeed, the “manifest appearance” of Paterson Baa1 rating says nothing about its one-day shutdown of all non-essential government services in 2016 (former CFO, Paterson, NJ, 2016), nor does the A2 rating of Harrison reveal that the town had to file a suit to reclaim withheld taxes from the newly developed Red Bull Arena (CFO, Harrison, NJ, 2016). Yet these are the dynamics that ratings are supposed to indicate and encapsulate. The limits to this process will be discussed next.

Limits to bond rating

Because of the contingent ways rating factors interact in each localized case, no rating methodology can be uniformly applied to all municipal bonds. Moody’s (2016: 7) is keen to point this out, writing that the “rating process involves a degree of judgment, or consideration of analytical issues not specifically addressed in the scorecard, that from time to time will cause a rating outcome to fall outside the expected range of outcomes based on a strict application of the factors presented herein.” To exemplify this, consider one former rating analyst’s account of Chicago’s sluggish rating performance. Chicago’s struggle with underfunded pension liabilities had at the time of the interview led to repeated downgrades by all major rating agencies.³ But:

Take out Chicago’s pension problem and Chicago is like an AA-rated credit. Its economy is very good; it's very diverse, people want to live there, they got great educational attainment in the city. They got all of these really good factors that you would say make them a good credit, but their pensions are dragging them down in such a way … that now they are sub-investment grade by most rating agencies … So, if you would take [qualitative judgment] out of the rating process you would miss this because pensions might have 10% weighting [in the rating methodology] but I would say that the influence of the pensions on Chicago’s rating is probably more like 80-90% (former rating analyst #2, 2016).

In this way, Chicago illustrates how the rating process requires mechanisms for accommodating the analytical (and indeed inevitably subjective) judgments necessary for assessing individual credit quality.

In the case of Moody’s (2016), these mechanisms are represented by “below-the-line” adjustments that can notch a rating up or down. Similarly, S&P (2013) refers to positive and negative “overriding factors” that can alter ratings or cap them at certain levels such as “sustained large positive fund balances” (8-9) or (the seemingly arbitrary) “lack of willingness” (18) to pay obligations. Fitch’s (2016) reluctance to apply a standardized weighting to its different factors speaks to a similar need to keep the process open to potential anomalies. This becomes particularly pertinent with regard to local political dynamics which by their very nature are difficult to statistically models. Consequently, the rating agencies emphasize the need for qualitative political analysis as much as statistical comparison because, as S&P (2013: 4) puts it, “variables such as economic conditions, debt levels, and financial performance can suggest when difficult decisions to restore fiscal balance might become necessary, but do little to suggest whether prudent decisions will be made.” While introducing possibilities for qualitative adjustments into the methodology, this speaks to how the rating agencies continuously need to grapple with a tension between standardization for the sake of commensuration and understanding localized particularities on their own terms. The regulatory aftermath of the subprime mortgage crisis is a particularly striking illustration of this.

Criticizing the rating agencies for being “inaccurate” in their ratings, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010⁴ called for more stringent accountability and transparency. Central to this reregulation was the empowerment of the Securities and Exchange Commission (SEC) to prescribe rules requiring all ratings to be undertaken in accordance with predetermined criteria and methodologies while ensuring that changes to these methodologies were applied consistently. These rules mandated rating agencies to disclose reasons for changing methodologies and to notify users of ratings of which methodology a rating is based on, when this methodology is changed, when an error is identified in the methodologies and when that error might impact the rating. Ratings are now to be accompanied by disclosures of their underlying assumptions, the data relied upon and other information that make it easier for users to understand them. Consequently, the agencies have become increasingly concerned that their municipal ratings are defensible with reference to published methodologies, use more data points to justify their case and document when a rating deviates from what would be expected using the standard formula (former rating analyst #1, 2016).

According to one former analyst, the rating process:

Has become a lot more bureaucratic … With the Dodd-Frank and SEC now regulating them, they are very driven by methodologies. The exceptions are very difficult to achieve and identify …. meaning that they have ten criteria that they follow and if you have something that is unique about yourself that is not in those ten criteria but that should compensate for them that’s very difficult to do. It’s a lot more of what I refer to as rating by numbers as opposed to incorporating the subjective factors … It’s just squeezing everybody to the norm so to speak and I think it takes away a lot of the opportunities for either higher or lower differences to occur (former rating analyst #6, 2016, emphasis added).

Although this could be partly read as the remarks of a disgruntled former employee, it does illustrate a more widespread sense among market actors that while the rating methodology traditionally would provide analysts with a toolbox to draw from in the creative process of evaluating localized credit risk, Dodd-Frank rendered it a list of checkboxes to be ticked off. Since Dodd-Frank the agencies increasingly “rate to the criteria,” allowing their methodologies to drive ratings above the specific credit qualities of the issuers (former rating analyst #3, 2016). Ironically, however, this push toward standardization and transparency has led to an increasing number of “split ratings.” That is, when a municipality receives widely different ratings from different agencies. As one former rating analyst explains, the agencies now “have to write criteria, update criteria, make criteria transparent in the market so they will only care about their own criteria and Moody’s might have different criteria than S&P or Fitch, so you’re going to have different outcomes as far as the ratings go” (former rating analyst #4, 2016). More than a technical obstacle this problem of standardization highlights the deeply contradictory character of commensuration; the agencies always need to be able to recognize local contingency while simultaneously reducing it to the coarse equivalence of the rating scale. The next section will turn to the politics of this process.

Politics of bond rating

When Hackworth (2007: 17) writes that “the shift to entrepreneurial or neoliberal urban governance is less a result of an organic shift to the right made in the face of capital flight than it is the result of an institutionally regulated (and policed) disciplining of localities,” he mobilizes a strong critique of the financial discipline conducted by rating agencies to which the collective consumption responsibilities of the local state is merely an impediment on debt repayment. What Hackworth (2007) does not do, however, is clarify the mechanisms through which this discipline is transmitted to cities. This is the potential contribution of a closer attention to the rating process, following Braun’s (2016) insistence that such micro-institutions should not merely be treated as objects of regulatory struggles but as sites of politics in their own right.

For Espeland and Stevens (1998: 329) “[s]ome instance of commensuration are so deeply institutionalized that they help to constitute what they purport to measure,” producing processes of “reactivity” as powerful forms of social meanings are “objectified or reified, that is, when social practices are organized to sustain the appearance that meaning stands outside the individual subjectivity, as part of the world.” Related to the performativity argument that became influential in critical financial studies with the intervention of Mackenzie and Millo (2003), this highlights how processes of commensuration do not just observe but change behaviors as actors seek to conform to standards they perceive as external and objective. In the fiscally starved landscape of austerity urbanism, bond rating can be considered to produce forms of reactivity in the sense that the criteria of the agencies become internalized within municipal financial administration—constructing a “neoliberal notion of budgetary normality as the hegemonic discourse against which democratic governments are judged and governed” (Paudyn, 2014: 5).

Such internalization of bond rating criteria in urban governance is starkly exemplified by the CFO of Elizabeth when asked to account for the city’s successful track record with the agencies. While emphasizing new economic development projects and the long experience of the administration, this respondent gives particular credit to continuous “close dialogue” with the agencies. Outlining how they make sure to keep the agencies updated on the fiscal health of the community, he states that “I consider them another boss, another entity I have to report to. I report to the mayor, I report to the council, I report to directors [and] I keep Moody's informed also … because they are the bond raters and it translates to a lot of dollars” (CFO, Elizabeth, NJ, 2016, emphasis added). This vivid portrayal of the rating agencies as “another boss” may be contested by other CFOs who nevertheless see the agencies “almost as auditors” or “advisors,” as:

Somebody else that you have to cater to, you have to take their recommendations seriously and you have to think of when you are structuring your budgets and financial statements: what impact is it going to be when the rating agencies look at this, when are we going to undertake these capital projects, how is this going to appear in our records? (CFO, Hoboken, NJ, 2016).

By representing Moody’s and other rating agencies in terms of “another boss” or an “advisor,” these financial processionals naturalize the rating agencies as unproblematic players in local administration, while reinforcing the notion that municipal debtors should monitor themselves according to these standards. However, if the notion of rating agencies as “another boss” exemplifies the politics of creditworthiness in particularly strong terms, a much more insidious mechanism is especially important for further understanding the “reactivity” of bond rating: the agencies’ concern with budget flexibility with regards to debt repayment.

Although wide-ranging, bond rating factors are essentially constructed as proxies for the ability of cities to adjust financial operations in order to keep repaying debt regardless of external economic shocks and competing financial commitments. This is an emphasis on flexible finances that is particularly evident in Moody’s (2016: 9) methodology where, for example, a large and diverse tax base is favorable because it indicates less vulnerability to recessions; meanwhile, higher median family income is deemed credit positive because it allows for “relative flexibility to increase property taxes in order to meet financial needs.” The assets and liabilities of a municipality are further indicators of its “cushion against the unexpected, its ability to meet existing financial obligations, and its flexibility to adjust to new ones” so that, for example, the size of the cash reserves expresses the “ability to adjust to changing circumstances” (Moody’s, 2016: 11). In terms of management, the “institutional framework” of the state in which a municipality operates “shapes its ability and flexibility to meet its responsibilities” while the presence of organized labor, pension liabilities or tax caps further reduce its flexibility to respond to bondholder needs first and foremost (Moody’s, 2016: 14). Similarly, Fitch’s (2016) factors include the municipality’s “[i]ndependent legal ability to raise operating revenue without external approval” (6) as well as “spending flexibility” (10) to judge its ability to respond to economic changes with revenue increases or expenditure cuts, while S&P (2013: 16) argues that “a government’s ability to implement timed and sound financial and operational decisions in response to economic and fiscal demands is a primary determinant of near-term changes in credit quality.”

While the agencies in this way rate municipalities in accordance with their ability to service debt in the face of contingencies such as economic downturns or state funding cuts, their search for flexibility is essentially concerned with only one thing: the municipality’s ability to revise all other commitments that could stand between bondholders and the debt service in the event of a fiscal conflict. The municipal budget should be flexible, but the promise to the bondholders is an absolute, inflexible commitment. This has profound effects on urban fiscal affairs, conditioning some cities to persistently occupy the lower rungs of creditworthiness while steering their more fortunate neighbors toward a politics, in particular, of attempting to as far as possible conserve budget surpluses. In the former category it means that, for example, New Jersey’s capital, Trenton, with its disproportionate number of tax-exempt state properties, will always struggle to achieve high ratings because of a weak tax base allowing for few extraordinary budget adjustments (CFO, Trenton, NJ, 2016). For the latter cities, on the other hand, achieving financial flexibility through generating and policing budget surpluses becomes a governing axiom, as explained by Hoboken’s CFO:

[The rating agencies] are big on surplus generation, and not using too much of your surplus … you need to make sure that you have that kind of flexibility in your finances where you have some surpluses … so that if something crazy happens with the post-employment benefits, pension system or the state’s ability finance state aid, you are able to handle that (CFO, Hoboken, NJ, 2016).

The rating agencies emphasize that their reports do not offer policy recommendations for improving ratings and simply indicate possibilities for rating change, but local financial professionals often take these as advice or guidelines for future improvement, illustrating how indicators originally devised to describe fiscal conditions for potential investors have become tools to reshape those very conditions.

In this sense, in addition to the general threat of a credit downgrade, the financial discipline that cities have come to experience is related to a set of very concrete mechanisms for judging and comparing their creditworthiness, formulated in the particular methodologies of specific rating agencies and transmitted to urban politics through their interaction with municipal financial administrators. As a form of reified commensuration, however, bond rating and its search for budget flexibility do not appear to be political or social but instead as encountering cities as objective criteria of the external world. As expressed in remarks by the CFO of Plainfield: “to the extent that the guidelines that the credit rating agencies are looking for [represent] financial responsibility … it informs policy within a lot of municipalities” (CFO, Plainfield, NJ, 2016). This illustrates how senior financial professionals insert the criteria of credit rating into the daily workings of government administrations, effectively melding the monitoring practices and performance standards of the rating agencies with the internal procedures and priorities of municipalities, so that “the criteria and modes of evaluation promoted and shared by private investors and financial actors transform the [local] state’s routine representations and practices as they adapt to these modes of calculation” (Lemoine, 2017: 5).

The act of commensuration itself is central to this process because it is first by being compared against the common metric of the rating scale that differently positioned municipalities are brought into relation with each other and assumed to operate according to the same formula, regardless of their particular economic geographies or local political dynamics. Through this, a discourse of financial responsibility is crafted in which a technocratic defense of budget flexibility becomes the chief aim of financial professionals, even if this contradicts the wishes of urban citizens or the local political body. In a “highly politicized” city like Newark where local councilors “want to use every penny,” it might even go so far as having the finance department “very busily hide [budget surpluses] in the financial record” so as to ensure it is not being depleted and the city can retain its financial flexibility, also against the potentially diverging priorities of democratically elected officials (former CFO, Newark, NJ, 2016). Processes of urban restructuring thus become embedded not only in the rollback of intergovernmental support that has forced cities to seek recourse in an increasingly speculative municipal bond market, but also in the relatively mundane technicalities of Moody’s rating scorecard.

Conclusion

Following calls for urban political economy to engage more thoroughly with financial markets, this paper has examined the municipal bond rating process. With close attention to the practices of the rating analysts, it has shown how this process relies on the interacting moments of breaking apart followed by reassembly, seeking to analytically isolate individual rating factors only to subsequently bring them together in a single indicator of default risk. In the process, concrete fiscal relations are reduced to a position on a scale from AAA to D while inequalities between prosperous and struggling localities appear not as relationships between people and places but as differential risk profiles of financial securities. But this is a contradictory process since the contingent uncertainties of default can never be completely written out of the picture. As such, municipal bond rating is a fraught and highly politicized process of commensuration in which rating analysts do not just passively observe local fiscal conditions but fundamentally help reconstitute them by steering municipal finance toward an increasing concern with budget flexibility.

Although budget flexibility might appear as a neutral measure of competent financial management, it obscures the conflict over competing social priorities that is at the heart of financialized urban governance. In particular, in its reified form, the politics of budget flexibility appears to stand outside of the actors in the municipal bond market, merely expressing an objective necessity to conform to seemingly external standards of good public finance. This effectively remakes urban politics by radically diminishing the room for social conflict over fiscal priorities, confirming Braun’s (2016: 267) contention that “there is ‘politics’ not only in the regulation of the marketising practices of the investment industry, but in those practices themselves.” While the paper, in this regard, has contributed to showing how market devices indeed are sites of politics, it is important to note that their relative power and influence is contingent on the broader markets which they help constitute. This is well illustrated in the area of municipal finance, where the influence of bond rating has grown in conjunction with a set of restructuring processes that have further exposed cities to the scrutiny of bond market actors. As such, while political economists may need techno-cultural approaches, the reverse is equally true if we are to identify which micro-institutions are particularly important to understand in this conjuncture.

Footnotes

Acknowledgements

Previous versions of this paper were presented in 2018 at the Annual Meeting of the Association of American Geographers and in the 5th Global Conference on Economic Geography. For comments and suggestions, I would like to thank Rachel Bok, Joseph A. Daniels, Martin Danyluk, Jamie Peck, Joe Penny, C. S. Ponder, Emily Rosenman, the anonymous reviewers and EPA editor Brett Christophers.

Declaration of conflicting interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author(s) disclosed receipt of the following financial support for the research, authorship and/or publication of this article: This research was made possible through funding from the UBC Faculty for Graduate & Postdoctoral Studies and the Larry Bell Urban Initiative.

Notes

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