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.

We would come to an issue that we considered nonnegotiable.  We would draw a line in the sand. 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 agreement by saying, “The NBA won’t agree to it.”

We had no direct communications with the NBA so we were at the Grizzlies’ mercy on what they said, but the end result was the same: it blew up the agreement that had been reached and we never even got to hear it directly from the NBA.

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 “our bond rating could decrease our rating 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 is considered definitive.  CFOs are the conduits for information and quotes attributed to rating agencies which just happen to support the CFO’s own opinions or position.

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 THE definitive indicator of smart financial management. 

That doesn’t mean that they mayors 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 2021.  It lists Standard & Poor’s rating for City of Memphis as AA and Moody’s at Aa2 (both agencies can give higher ratings for municipal bonds).

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, has said it well: a bond rating “says a lot about where a community is in its life cycle and very little about its management.  It 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 in the fact that in Memphis concentrated poverty is intractable, that at least 32,000 affordable houses, that wages are too low, and personal incomes lag.  Their concern is only if the 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 recommendations, and spoken in Memphis.  They work for the residents, not investors.  They should seek the approval 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 to have culpability 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, as politicians like to say, but because it ensures bond investors will be paid.   

The problem is that when fund reserves are too large, it means 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. 

While some places agonize over removing any money from fund balances, as if it is violating some Golden Rule of public financial management, it’s worth remembering that city and county governments are generally resilient.  There was even a time during the Herenton Administration when the fund balance was depleted – and the bond rating did not go down.  

Demystifying Terms

While it’s inarguably 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.            

Because CFOs cloak explanations about bond ratings and fund balances in arcane terms and confusing language, whenever they are brought up, they are essentially a trump card for stopping discussions and questions in their tracks.

Local legislative officials regularly accept what they are told about bond ratings and fund reserves, because over the decades, only a couple of them have come from a financial management background and know the questions to ask and how to evaluate what they were being told.

As a result, when the subject of bond ratings comes up and finance officials raise the specter of a downgrade, no one even asks how much more a lower bond rating would actually raise cost for bond payments.   

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 city and county budgets and to remove their mystery.

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