Feb. 12 (Bloomberg) -- Break them up!

The cry has gone up again to fix the companies that grade securities. In recent days, critics have called for investors, rather than issuers, to pay for such assessments. They also want all municipal-bond ratings raised to the global scale enjoyed by corporate securities -- or do away with the companies altogether.

Quick! Somebody do something!

You can't blame people for being angry. The pundits say the raters helped produce the current crisis because they assigned high grades to the crazy collateralized-debt obligations stuffed with subprime mortgages that are at the center of this mess.

Now the rating companies are overcompensating, downgrading everything in sight, including the bond insurers. That, in turn, is cascading through the system, affecting the auction-rate and short-term markets, and threatening the banks with an additional $40 billion to $70 billion (or $7 billion, or $10 billion -- basically, take your pick) in writedowns and losses.

To hear the critics tell it, the rating companies are like the gang that couldn't shoot straight.

Predictably enough, the real result of this crocodile concern is hot air and hyperbole. Putting aside the suggestion to do away with the companies that rate securities, let's think about the alternatives.

How about having investors subscribe to rating-company services? Isn't there a conflict of interest in being paid by the very people (the issuers) who want you to rate their securities?

Thorny Question

This is a thorny question, all right, but I don't see how you get around it, at least if you want a municipal-bond market, like the one you have now.

There are at least 50,000 entities authorized to sell municipal bonds. About 10,000 to 15,000 transactions are made every year. Many of them are sold by the same issuer -- that is, the state of Wisconsin may come to market three or four times a year, the city of New York five or six. So, let's say between 5,000 and 7,000 separate issuers sell bonds annually.

Many of those, however, don't sell bonds multiple times; many don't even sell bonds every year, but only come to market every few years. The average size of a muni-bond issue in 2007 was $34 million. Some years back, I did a little study and found that almost three-quarters of issues sold every year were less than $10 million. The figure wouldn't be much higher now.

Cheap Investors

The municipal market doesn't lend itself to the investor- subscription model. There are too many issuers, especially small and infrequent ones. You couldn't possibly get enough people to pay the amount needed to support the staff to cover it adequately. This is most relevant now that individual investors dominate the market, a modern phenomenon dating from the 1980s.

The institutional investors, who already pay the rating companies for full access to their research, have their own analytical staffs. Individual investors, on the other hand, are cheap. To the extent they do any research at all, they take a look at what the rating companies now provide.

Of course, once upon a time, investors footed the bill. If you tried that approach today, you may wind up with a boutique operation covering maybe 500 state and local bond issuers.

Then there's the idea of having the rating companies apply corporate grades to all munis. Moody's Investors Service opened this can of worms last year when announcing its intention to apply corporate ratings to taxable municipals bought by overseas investors, tacitly admitting that muni bonds are rated too low.

Not all the rating companies agree, and neither do I. In 2007, according to the Bond Buyer newspaper, $429 billion of municipal bonds was sold. Of that amount, $131 billion was in general obligation bonds backed by taxes. Everything else was covered by some form of revenue.

Tax Caps

In theory, according to proponents, all the GO bonds should be rated AAA. Oh, really? How would you then rate Californian issuers, almost all of whom are relatively constrained by property-tax caps and other calls upon their tax bases? I need not remind you that California isn't the only state with these kinds of tax limits.

When bubbles burst, it's never pretty. Let's not make the municipal market collateral damage in any misguided rush to ``fix'' the rating companies.

(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net.

Last Updated: February 12, 2008 00:11 EST