Fix how muni bonds are rated - officials

NEW YORK (CNNMoney.com) -- Government officials urged credit rating agencies Wednesday to rethink the way they rate municipal bonds, arguing that the current system saddles local governments and taxpayers with unnecessary costs.

Lawmakers and witnesses testifying before the House Financial Services Committee said that many cities and states are being given high-risk ratings when the likelihood of their defaulting on their bonds is slim. As a result, agencies are paying for bond insurance they don't really need, they said.

Governments and public authorities face steep increases in borrowing costs because investors are losing confidence in the credit markets and the bond insurers that guarantee the debt.

"This has got to be fixed," said Rep. Barney Frank D-Mass. "We cannot tolerate as a society this situation where people are required to pay so much."

Calls by lawmakers were echoed by state officials, including California State Treasurer Bill Lockyer and Connecticut State Attorney General Richard Blumenthal, who were among the dozen witnesses set to testify Wednesday.

State and federal officials argued that municipal bonds, used by local governments to fund projects like repairing roads or building schools, be rated the same way that corporate debt is measured and based on the likelihood of default.

Moody's Investor Services and Fitch Ratings, two of the three major credit rating agencies, did not immediately respond to calls seeking comment.

Standard & Poor's said it has not initiated any changes, but defended the way it rated municipal debt in a statement last week, arguing that local governments and their respective credit quality acted in a distinctly different manner from public companies.

Wednesday's hearing comes at a time of great turmoil for municipal bond market.

Some financial guarantors have already lost their AAA ratings, while others like Ambac (ABK) and MBIA (MBI) remain at risk of downgrades.

The insurers' troubles are causing local governments to rethink buying bond insurance. A downgrade of their financial guarantor would drive up their cost of borrowing.