Credit Ratings and the Cost of Municipal Financing

Moody’s recalibrated its municipal bond rating scale in 2010, upgrading $2.2 trillion of municipal debt. This event allows us to test whether investors rely on ratings to assess credit risk, free from confounding regulatory effects and changing fundamentals. We find the upgrades lowered credit spreads and expanded municipal debt capacity. These effects are stronger among more opaque issuers. We conclude that rating agencies will remain relevant despite legislators’ efforts to reduce regulatory reliance on ratings. Our results further commend improved disclosure to mitigate mechanistic reliance on ratings and inefficiencies due to rating standards that vary across asset classes.