Thumbnail: The financial terms surrounding bond ratings and fund balances often bring meaningful discussions to a standstill in city and county government as finance officials quote people who are not in the room.
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When Rick Masson, Robert Spence, and I negotiated the agreement to bring the Grizzlies from Vancouver to Memphis, it often felt like there was an unseen third party in the room.
It went like this.
We would get hung up over a difficult issue. We would draw a line in the sand, and after gnashing of teeth, if not raised voices, the Grizzlies’ team would grudgingly make a concession and agreement would be reached.
Or at least that’s what we thought.
Despite thinking that we had settled a contentious issue, the Grizzlies would return to the negotiating table and blow up our deal with the comment, “The NBA won’t agree to it.”
We had no lines of communications with the NBA so we were at the Grizzlies’ mercy on what they had been told, but the end result was the same: it blew up the agreement and we never even saw the person who did it.
Bond Ratings Aren’t About The Public
That must be how City Council and County Commissioners feel at times during budget hearings.
It’s not unusual for CFOs, in the midst of questions about budgets, to bring discussions to an end by saying something like “our bond rating agencies think…” or “that our bond rating could decrease if you do that.”
In this analogy, rating agencies are to local government what the NBA was to Grizzlies negotiations: an unseen party whose opinion considered definitive. CFOs are the conduits for information and the quotes attributed to rating agencies are generally just what is needed to support their own opinions or assumptions.
But here’s something else that’s never said: bond ratings aren’t about taxpayers. They’re about bond buyers.
Another thing you’ll never hear: despite mayors’ speeches and budget presentations, bond ratings are not a definitive indicator of smart financial management. That doesn’t mean that Mayor Strickland won’t say again that the bond ratings is confirmation that his administration’s emphasis on core services is working.
The City of Memphis online data hub even lists the yearly bond rating as if it’s a critical measurement of strong financial management; however, it has not been updated since March, 2019. It lists Standard & Poor’s rating for City of Memphis as AA and Moody’s at Aa2 (both agencies have higher ratings).
If anything, bond ratings are to government financial management what Wall Street is to the economy. And like Wall Street, they work in the interest of investors.
Fooling Local Government
Charles Marohn, president of Smart Towns, recently said it well: a bond rating “says a lot about where a community is in its life cycle and very little about its management. I doesn’t say anything about how the city analyzes the viability of projects. It says nothing about its financial productivity or return on investment. It doesn’t even say anything about the quality of life there and whether people will want to stick around once the sheen wears off.
“That’s because the ratings agencies don’t care about any of these factors. I’ve met with them and, while the people that work there and do these analyses are smart and interesting, they work for investors. They don’t care if the pipe in the ground doesn’t support enough connection to retire the debt to put it there. They don’t care if the road is really expensive to build and won’t yield anywhere near the tax base needed to sustain it. They don’t care that each new subdivision the city does puts it deeper in a financial hole.
“All they care about is the community’s present capacity to retire new debt.”
The rating agencies aren’t interested that concentrated poverty is increasing in more neighborhoods, that there is a 32,000 need for affordable housing, that wages are too low, and personal incomes are lagging. Their concern is whether their bond buyers will be paid back.
“Let’s not let our local governments be fooled about whom they work for,” said Mr. Marohn, who has worked, written reports, and spoken in Memphis. They work for the residents, not investors. They should seek the approve of their citizens, not the ratings agencies.”
No Fund Balance Rules
The reputation of rating agencies took a beating after the Great Recession, because they were seen as culpable in the crisis in the first place. In the intervening years, the methodology and credibility of ratings agencies have been called into question. As a result, bond ratings are no longer the end all, be all for investors, who often see them as a starting point, while CFOs around the country are working directly with investors.
In budget presentations to legislative bodies, the other side of the coin from bond ratings is fund reserves. It too is often used to bring a halt to discussions because of the mystery around how much is needed and how much is too little and how much is too much. The answer regularly and conveniently supports the finance official’s point of view and defies discussion of an esoteric aspect of government operations.
When it comes to the fund balance, rating agencies tend toward more is better, not so much because the fund balance will be there, if needed, during an economic downturn to pay for vital public services, but because it ensures that the bond payments to investors can be made.
That said, fund reserves that are too large raise concerns that governments are hoarding money that could be better spent on neighborhoods.
The sizes of fund balances and the policies to determine them vary across the country. Shelby County has not balanced a budget without taking money from the reserves for several years and City of Memphis is considering it for the coming fiscal year.
While some will agonize over it, as if it is violating some rule of public financial management, it’s worth remembering that city and county governments are generally resilient. There was a time during the Herenton Administration when the fund balance was depleted.
Demystifying Terms
While it’s good for governments to have fund reserves in the event of the so-called “rainy day,” how large they should be is a contentious issue because there is no one answer that works for all governments.
Local legislative officials regularly accept what they are told about bond ratings and fund reserves, because over the decades, only a couple of them were from a financial management background and knew questions to ask and how to evaluate what they were told.
Some basic questions are ignored: when the subject of bond ratings comes up and finance officials raise the specter of a downgrade, no one asks how much a lower bond rating it would cost. The answer might be surprising to elected officials.
The first step in more productive budget discussions is not to allow the use of financial terms to shut down debate and for budget committee members to conduct their own due diligence to understand not just the meanings of the terms but how they impact county budgets and to remove their mystery.
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