West Haven, Connecticut, which has closed four school buildingsover the past two years and fired 14 teachers to help cut itsbudget deficit, is about to pay Moody's Investors Service almostdouble what it cost six years ago for a credit rating.

Joseph Mancini, finance director for the city of 55,000 nearYale University, says he has no choice other than to meet thedemands of Moody's after the municipality's bonds were downgradedto Baa1 in January, three levels above junk, from A2.

“The market's going to punish us for the rating we're at,”Mancini said in a telephone interview. “If we didn't get it rated,we would be punished even more.”

Four years after faulty ratings helped trigger the worstfinancial crisis since the Great Depression, Moody's and Standard& Poor's are as dominant as ever, boosting fees at a fasterrate than inflation as new competition promised by lawmakers failedto materialize.

New York-based Moody's raised its rates by 5 percent on averagethis year, and may impose a similar increase in 2012, ChiefExecutive Officer Ray McDaniel said at a conference for stockinvestors on Nov. 8.

Even after provisions of the Dodd-Frank Act cut reliance onratings and encouraged more companies to enter the industry, the$40 trillion worldwide bond market mostly follows the same rulesthat have determined since the 1930s who gets access to cash and atwhat interest rates.

“If I don't have two ratings on a bond, I cannot sell it,” saidTimothy Cox, executive director of debt capital markets at MizuhoSecurities USA Inc. in New York, who's been working in thefixed-income market for 30 years. “No money manager is going to buyit,” he said in a telephone interview.

At least one of the three biggest credit-rating companies washired for 98 percent of municipal bonds bigger than $50 millionthis year, up from 94 percent in 2007, according to data compiledby Bloomberg. About 99 percent of U.S. corporate issues have agrade from one of the three, compared with 98 percent four yearsago, the data show.

Cities and states are paying higher fees even as Moody's givesthem lower grades relative to companies, according to a studyreleased in August by professors at Indiana University, AmericanUniversity and Rice University. The company favors bonds backed byassets such as mortgages, which cost more to rate, the studyshowed. Moody's said the study is flawed.

Little Competition

Thousands of top-rated mortgage bonds plummeted in value in2008, showing that S&P and Moody's engaged in a “race to thebottom” to inflate their grades to win business from Wall Streetbanks, according to a report released in April by a Senatesubcommittee. The collapse contributed to the credit-market seizurethat brought down Lehman Brothers Holdings Inc. and CountrywideFinancial Corp.

Since then, Jules Kroll, the founder of theprivate-investigation firm that bears his name, and billionaire JoeMansueto of Morningstar Inc. entered the business. Their firms havegained little market share as bond investors and regulatorscontinue to use S&P, Moody's and Fitch Ratings to measurerisk.

The three companies provide 97 percent of all credit ratings,the U.S. Securities and Exchange Commission said in a Septemberreport. S&P leads with a 42 percent share, Moody's holds 37percent and Fitch, majority-owned by Paris-based Fimalac SA, is at18 percent.

“It's very hard to convince someone to stop using S&P andMoody's ratings because they're such a market norm,” James Gellert,chief executive officer of Rapid Ratings, which charges investorsrather than issuers for its grades, said in a telephone interview.“If you don't have one, people will wonder what's wrong withyou.”

Even Namibia decided it needed a second rating, from Moody's, inSeptember before selling $500 million of bonds to foreign investorsfor the first time. The southern African nation got a Baa3, thelowest level of investment grade and equivalent to the BBB- italready had from Fitch. “Investors want a second opinion,” SaaraKuugongelwa-Amadhila, the country's finance minister in Windhoek,said in a telephone interview.

Moody's standard fees to rate U.S. municipal bonds jumped asmuch as 21 percent this year, according to lists provided to PortArthur, Texas. Some fees fell while others rose, said MichaelRowan, managing director of the company's commercial group,established last year to ensure that analysts are separated frombusiness negotiations. The prices are “fair and reasonable,” hesaid.

“We don't look to compete on price,” Rowan said in a telephoneinterview. “We look to compete based on the quality of our ratingsand the value of our ratings.”

Linda Huber, the company's chief financial officer, said inSeptember that there are limited alternatives. “A Moody's rating isan important thing,” Huber said at a conference for stock investorsorganized by Goldman Sachs Group Inc. “If it's not there, it'snoticed by the market. Cost of capital will go up.”

Moody's and S&P are able to raise prices because the two area “natural duopoly,” Warren Buffett, the billionaire chairman ofOmaha, Nebraska-based Berkshire Hathaway Inc., told the FinancialCrisis Inquiry Commission last year. Berkshire is Moody's largestshareholder, with a 12.8 percent stake, and bought into thebusiness because of that pricing power, he said.

'Unwilling Customer'

“There are very few businesses that have the competitiveposition that Moody's and Standard & Poor's have,” Buffettsaid. Berkshire is an “unwilling customer” of Moody's when itissues bonds, Buffett said. “We pay for ratings, which I don'tlike.”

Moody's raised its standard fee this year on corporate bondofferings to 5 basis points, or 0.05 percentage point, of theamount being raised with a minimum of $73,000, from 4.65 basispoints in 2010, according to Michael Meltz, a JPMorgan Chase &Co. analyst in New York. S&P asks for 4.95 basis points with an$80,000 minimum, up from 4.75 basis points and a $72,500 minimumlast year. It would cost $497,500 to have both companies evaluate a$500 million debt sale.

S&P and Moody's haven't lost business as a result of theirincreases, said Peter Appert, an analyst at Piper Jaffray & Co.in San Francisco.

“Pricing has no bearing on whether somebody is going to issuedebt or not,” Appert said in a telephone interview. The extrainterest a borrower would have to pay on an unrated bond is a“whole lot more” than the cost of a rating, he said.

That's helped make credit ratings a lucrative business. Moody'sCorp.'s return on capital, a measure of profitability, was 71.6percent last year, the fourth-highest among companies in theS&P 500 Index, while its operating margin was 38 percent, whichranked 25th, Bloomberg data show.

The company received $1.47 billion in ratings revenue last year,or $1.22 million for each credit analyst and supervisor, accordingto data compiled by Bloomberg and the SEC report. S&P made $1.7billion, or $1.26 million per analyst and supervisor, while Fitch'srevenue was $554 million, or $528,160.

Moody's will use price increases to help achieve its goal oflow-double-digit revenue growth, McDaniel said at the conference onNov. 8. A 5 percent price increase for next year would be on the“high side” if bond issuance stays flat, he said.

The Federal Reserve's preferred price index, which measuresinflation excluding food and fuel, rose 1.6 percent in Septemberfrom a year earlier.

West Haven's Fees

Ed Sweeney, a spokesman for S&P, a unit of New York-basedMcGraw-Hill Cos., said the company's pricing “reflects the valueprovided to the market.” Daniel Noonan, a Fitch spokesman, saidFimalac doesn't disclose pricing information.

West Haven is paying Moody's $16,400 to grade a planned $45million bond, which it will use to refinance debt, up from $8,500to rate a $32 million sale in 2005, Mancini said. The city is alsopaying $15,300 for a grade from S&P, which said last month itwas considering cutting West Haven's rating from BBB, Mancinisaid.

“You can choose not to have your bonds rated,” Mancini said.“For a city like West Haven, in the financial situation it's in, itwould be a pretty difficult thing to market.”

The $31,700 of fees would pay a new teacher's salary inConnecticut for about nine months, according to data from theNational Education Association, the Washington-based union.

Cities and towns are “trapped” by the market's continuedreliance on ratings, said Representative Barney Frank ofMassachusetts, the ranking Democrat on the House Financial ServicesCommittee.

“They are extorting the cities of this country,” Frank said in atelephone interview. “By the criteria they use for the privatesector, every full faith and credit municipal bond should beAAA.”

Bonds from cities and countries are rated “more harshly” thanthose of banks and corporations, according to the academic study,which was released in August by Jess Cornaggia of IndianaUniversity, Kimberly J. Cornaggia of American University, and JohnE. Hund from Rice. There's “virtually no chance” of default onbonds backed by the ability to tax, Frank said.

Last year, after Frank and other politicians complained, Moody'sand Fitch said they would rate U.S. state and local governments onthe same scale as companies. S&P says its ratings arecomparable and no across the board adjustments are needed.

U.S. Loses AAA

S&P lowered its ratings for thousands of municipal bondsafter Aug. 5, when it cut the U.S. from AAA. Downgrades ofmunicipal debt outpaced upgrades in the third quarter by thelargest margin since 2008, according to a Moody's report. Thereductions are “preposterous,” Frank said.

The U.S. downgrade triggered a loss of $9.7 trillion in marketvalue from global equities last quarter. Buffett said the U.S.should be “quadruple-A,” while John Bellows, acting assistantTreasury secretary for economic policy, said S&P had made a $2trillion mistake in its math. A Bloomberg survey of 1,031subscribers found that 57 percent agreed with S&P'sdecision.

In 1936, the Office of the Comptroller of the Currency bannedbanks from holding bonds that were below investment grade. The SECbegan using ratings in its rules in 1975, specifying that the onlycompanies whose grades could be used were S&P, Moody's andFitch. Those firms were designated nationally recognizedstatistical rating organizations, or NRSROs. There are nownine.

“Regulators started telling their financial institutions,starting with the banks, you must pay attention to only thesehandful of entities,” Larry White, a professor at New YorkUniversity's Stern School of Business who's testified beforeCongress about credit ratings, said in a telephone interview. “Thatgives the NRSROs a lock.”

After the Dodd-Frank financial-regulation overhaul instructedregulators to strip ratings from rules, bank supervisors arestruggling to find a substitute measure of risk. Making the changeis difficult because the international bank capital standards knownas Basel III still use ratings, David Wilson, chief national bankexaminer at the OCC, told Congress at a hearing in July.

Much of the credit raters' power comes from mutual funds,pension managers and other investors using their grades as cutoffsor triggers in contracts, Mizuho's Cox said. “The first thing weask is what are they rated and the discussion goes from there,” hesaid.

Morningstar Expands

Moody's, S&P and Fitch face limited competition instructured finance. Kroll started a rating company that beganevaluating commercial-mortgage backed securities this year andplans to expand into municipal bonds and residential mortgages.

Morningstar, the Chicago-based mutual-fund data company thatbought a credit-rating business last year, has rated 12 of the 32commercial-mortgage-backed securities issued this year.

At least nine of those 12 were also rated by Moody's, S&P orFitch, Bloomberg data show. Morningstar plans to expand into bondsbacked by residential mortgages, Robert Dobilas, president of theratings business, said in a telephone interview.

Regulators are considering other measures which may encouragecompetitors to Moody's, S&P and Fitch. In Europe, regulationswere proposed today that would require companies to periodicallyrotate the firm they use to rate their credit.

“Credit rating agencies should follow stricter rules, be moretransparent about their ratings and be held accountable for theirmistakes,” Michel Barnier, the European Union's financial serviceschief, said in a statement. “I also want to see increasedcompetition in this sector.”

Douglas Peterson, who took over as S&P's president inSeptember, met with Frank on Nov. 3 to express concern over a draftof the European proposals, according to Frank. He also visited theSEC to discuss a plan by Senator Al Franken, Democrat of Minnesota,to create a board to give out rating assignments in structuredfinance.

“The agencies are as powerful as ever and will remain so,” GlennReynolds, the chief executive officer of New York-based independentdebt research firm CreditSights Inc., who has testified to Congresson ratings reform, said in a telephone interview. “It's economicefficiency to pay the man and go through the turnstile.”

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