Credit ratings affect political fortunes of those in office, with an upgrade of public debt helping the re-election of those holding power at the time. By allowing the authorities to raise money at a lower cost, an upgraded credit rating lets political incumbents avoid spending cuts and tax rises and helps them maintain spending on public goods and programmes.
That, in its most simple form, is the conclusion we have reached after an intensive study of the relationship between credit ratings and results at the ballot box. To the question posed in the title of our study ‘Can credit rating agencies affect election outcomes?’ our answer is “Yes”.
True, there are differences between the effect on different political parties and in terms of the impact on different tiers of government. We shall go into these issues in a moment. First, a look at how we were able to conduct our research and reach the conclusions that we do.
Our study concentrated on municipal debt and creditworthiness in the United States, and was made possible by a restructuring in the spring of 2010 by Moody’s, one of the world’s largest credit rating agencies (CRAs), of the system whereby it graded the quality of American municipalities. By merging what had been two types of ratings into one, Moody’s upgraded the ratings of nearly 18,000 municipal bodies.
In some cases, these upgrades amounted to three “notches” on the ratings scale. But, critically from our point of view, these upgrades had nothing whatever to do with either the creditworthiness of the entity concerned nor the outlook for the local or regional economy.
As Moody’s put it, the general upgrade reflected only the merging of the two previous ratings into one and “does not reflect an improvement in credit quality or a change in our opinion [about the issuer]”. Thus we were able to study the political impact of improved credit ratings that were entirely unconnected to any change in the credit outlook for the bond-issuer concerned.
Put another way, we could isolate and then study the effects that were entirely attributable to the changes in credit ratings and to nothing else. Helping us in this was the fact that not all US municipal bonds were affected by the decision of Moody’s to restructure and re-calibrate its ratings system. Not all municipal bodies are rated by Moody’s, thus were outside the restructuring exercise, as were those local governments that did not have any outstanding bonds. A third category unaffected by the recalibration was made up of those local bodies that were already correctly rated by Moody’s.
Taken together, these three categories make up a control group against which we can measure our findings in relation to those municipalities whose credit rating improved as a result of the Moody’s exercise.
Before looking at the results, let’s look at ways in which an improved credit rating could bolster the political fortunes of those in office. America’s municipal bond market has some unique features, not least in the tax treatment of the securities concerned, but its role as a key source of local government finance makes our research widely applicable across democratic societies.
An improved credit rating makes borrowing easier and less costly for the municipality concerned, allowing it to spend either the same – if the alternative is a cut to expenditure – or more on construction and infrastructure and on public services such as schools, policing and libraries. By contrast, a credit downgrade would be likely to increase the difficulty and cost of borrowing and raise the prospect of cuts to capital spending and public services.
Thus, a municipality with an improved credit rating will, assuming it takes advantage of this new, higher rating, as outlined above, be in a position to maintain or improve the provision of public goods, whether roads or education services. This in itself is likely to result in a rise in voter approval of the political incumbents, given the public goods concerned presumably reflect the priorities of a majority of electors.
Beyond this, there are important knock-on effects from maintained or increased expenditure. Previously at-risk jobs on the public payroll could be safeguarded and there may be an increase in the size of the municipal workforce. Both these outcomes are likely to burnish the incumbents’ reputation in the eyes of the beneficiaries.
The private sector may benefit in a number of ways from maintained or increased expenditure: as a contractor for the provision of public goods such as road construction, as the beneficiary from the reduced need to put up taxes and as the recipient of higher consumer spending by those on the public payroll.
All this, of course, assumes that CRA ratings are influential in this market – were that not the case then the argument for a link between a ratings upgrade and improved political prospects would be weakened. In fact, the CRAs are very influential in the world of municipal bonds, for three reasons.
One, the municipalities comprise a large group of relatively small issuers, thus gathering information on each one is a costly exercise for which the CRAs are better suited than even sizeable investors. Two, there is a large number of private investors in this market who rely on the CRAs as their main source of information.
Three, both official regulations and the internal policies of the companies concerned mandate the use of ratings in the asset selection of institutional investors.
Our sample included local government units such as counties, cities, townships, school districts and public utility districts, but excluded the states of the union. We then grouped our municipalities together at the county level. The findings spoke for themselves in disclosing a marked relationship between the upgrading of a municipality’s credit rating and the ballot-box performance of political incumbents.
For elections to the US Congress, we found that a ten per cent increase in the proportion of upgraded local governments in a county translates as a 1.6 per cent increase in the share of the vote of the incumbent candidate. For elections to the US Senate, the increase in the vote share is 5.1 per cent for the incumbent.
It is a similar story for presidential elections, where the same ten per cent increase in the proportion of upgraded local governments in a county translates into a two per cent rise in the share of the votes cast for the incumbents’ presidential candidate. In mayoral elections, the rise is 16 per cent.
Re-election chances are also significantly improved by credit-rating upgrades. That same ten per cent rise in the proportion of upgraded local governments in a county translates into a 4.6 per cent improvement in the chances of the incumbent member of Congress being re-elected and a 26 per cent increase in the re-election chances of the city mayor. For elections to the Senate, the chances of the incumbent party’s candidate winning the largest share of the vote rose by 9.7 per cent, with a 6.6 per cent increase in the chances of the incumbent party’s presidential candidate doing the same.
Interestingly, we found only a weak link between credit upgrades and the election chances of candidates for state governorships.
Furthermore, the positive effects of ratings upgrades was markedly more pronounced when the incumbents are from the Democratic Party rather than their Republican opponents. No-one is suggesting the ratings-upgrade effect is playing political favourites. Rather, it seems the Democrats are much more likely to use the additional manoeuvring room afforded by the bond upgrade to maintain or increase local government expenditure and employment than are the Republicans, with their long tradition of fiscal restraint.
This makes it more likely that a bond upgrade will benefit Democrat rather than Republican incumbents, for the simple reason that the former are more likely to take advantage of the increased ability to borrow on capital markets to support the consumption of public goods.
In other words, for political incumbents to benefit from an upgraded credit rating they need to make use of it.