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Municipal finance has long been a cesspool. States, towns, hospitals, transit authorities, all have long been ripe for the picking. Sometimes local officials are paid off (anything from cold hard cash to gifts to skybox tickets), but much of the time, there’s no need to go to such lengths, since preying on their ignorance will do. As we’ve pointed out, even though these bodies often hire consultants, those advisors are often either not up to the task (how can people who don’t know finance vet an expert?) and/or have bad incentives (more complicated deals, which are generally more breakage prone, tend to produce higher consulting fees).

Dave Dayen highlighted one example yesterday: the city of Oakland has decided rather than pay $15 million in termination fees to get out of an interest rate swap deal gone bad:

In other words, the headline is: “Oakland to Goldman: Drop Dead.” I sincerely doubt that Goldman would litigate to get Oakland to pay the termination fee, but it will probably instead enlist enforcers, meaning the rating agencies, to issue the usual threats about how Oakland will be downgraded and shunned by investors for daring to press hard to have a transaction renegotiated. Funny how it’s OK in our society to break contacts with individuals over their pensions funds, but not with financial firms, when ZIRP (a tax on savers implemented to prop up the banks that wrecked the economy) is making many of these municipal swaps profitable beyond their wildest dreams.

But the case I like best so far is wee Moberly, Missouri. The New York Times got up in arms last month that a town of 14,000 is repudiating a bond guarantee that it was rushed into by a state authority:

S&P immediately whacked Moberly’s bond rating from single A to single B (junk), even though the creditworthiness of the outstanding bonds had nada to do with the guarantee. Indeed, if it tried honoring the pledge, the bonds would probably be toast. Missouri state representative Jay Barnes called the initial rating into question:

The Times story also had “market analysts” threatening that Moberly’s defiance might taint the credit of other towns in Missouri. By any logical standard, that’s garbage, but this is how the creditor Mafia operates. Matt Stoller described an earlier incident:

That press release is here. S&P was aggressively killing mortgage servicing regulation and rules to prevent fraudulent or predatory mortgage lending.

Now Moberly is in an interesting position. Its bonds have been downgraded, meaning if any investor were to sell them, they’d take a loss. And if the town were to issue new bonds, it would have to pay a huge premium (unless it was able to sell them to local loyalists). But there is no reason to think that anyone who keeps the Moberly bonds to maturity will lose money. And given that the town’s budget is under strain, it probably isn’t planning to increase its commitments by issuing new bonds of its own any time soon. In other words, the punitive downgrade is a wet noodle lashing.

The flip side is all sorts of pressure from the state is being brought to bear, and local officials may knuckle under for self-interested reasons. But I’m rooting for little Moberly, and if they can pull this off, it might persuade other local bodies to stand up when they have been railroaded into bad deals.