StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

What's in a Downgrade?

08 Aug 2011
Posted by Andrew Samwick

Not much, in my opinion.  In my last post, I argued that I'd take the debt deal even at the expense of the negative publicity we got for the juvenile way the negotiations were conducted.  So we avoided default and got downgraded by S&P anyway.  S&P's arithmetic mistake aside, I don't think potential investors in U.S. Treasuries relied too much on its previous AAA rating in actively valuing the bonds and bills.  And even if they did, they should be only minimally bothered by its current AA+ rating.  Potential investors have plenty of public information on current and projected cash flows of the U.S. government.  In those circumstances, there is little value added by a ratings agency's grade.

Where ratings agencies can add value is in rating securities that are harder to value.  I cannot say it better than E.J. Dionne did:

And to complete this portrait of fecklessness, Standard & Poor’s, which once happily and profitably stamped triple-A ratings on rip-off mortgage-backed securities, ended the week by downgrading the federal government’s creditworthiness. S&P once caved to pressure from Goldman Sachs in its rating of private securities, yet it refused even to pause in its dissing of American creditworthiness despite the Obama administration’s successful challenge to some of its numbers. We need to learn far more about what forces pushed S&P to this outlandish and highly politicized decision. [links in original]

The consequences of the downgrade, if any, will play out over time in the level of the term structure for U.S. Treasuries.  At present, the U.S. government can borrow at ridiculously low levels.  We should do so, as needed, to support investment that will boost output, employment, and productivity in the future.

Triple A rating means that

Triple A rating means that the rating agency concludes that there is no risk that debt service (interest and maturing debt) will be delayed. The assessement is based on the economy, the debt burden, the government, and finances. It seems to me that the federal government deserved a downgrade on the basis of government processes -- members of Congress saying that a default was not a big deal, for instance -- well before the eventual August deal. The agencies could not, in all good conscience, tell potential investors that US debt service was an absolute lock to be paid on a timely basis. And, having gotten through this fiasco, the attitude in Congress appears to continue to be one of "hold debt service hostage before every debt ceiling discussion." Does that indicate triple A? Not in my book.

What's in a downgrade?

Loss of trust in the financial system, apparently.

The markets crashed today.

Looks like Bank of America is in trouble.

Trust is everything. Intractable TEA party destroyed it.

Investment advisor advice; DC stupidity

Our firm, WTAS, which is mid-sized, said that US corporate P/E ratings were lower now than at particularly bad points in 2007 - 2010, and so may be select asset allocation benefits. Also hear you re two-facedness of S&P and ratings.

Hopefully this will help knock some sense into DC's boneheads - just like Federal Reserve is meeting tomorrow, they should be doing so now too, and not with another inane "kick the can down the road" piece of legislation. [Which as you know is essentially what Congress has done for multiple years now, with so-called mandatory Medicare physician payment cuts magically being "fixed" year after year]

Jobs and Bank Balance Sheets

The market was over priced, the hens will come home to roost on the Citi, BoA and Chase balance sheets soon enough.

I do not think the G7 announcement to cover the Euro economies applied to the US. US can do the deal on its banksters, and needs to stop delaying. The Euro is messier.

And if the US defaults on SS and medicare, and ignores human suffering to fund war profits when do they default on foreign debt?

The problems: disinterested and irresponsible high income taxpayers (those who should care do not want to pay), the economy, bank and fed balance sheets ignored, lack of infrastructure investment, wars of waste and the intactible austerity view of future uncivil society with no safety nets.

What is Honduras' rating?

Best post I saw elsewhere

The stock market lost over a trillion dollars today.

It's much better than a tax on the wealthy.

If Congress had come up with a tax increase on the wealthy AND authorized a debt increase on the money it had already committed to spending, AND, in addition, if they had made a commitment to trim spending to the degree Obama recommended (4 trillion),

Then this day would not have happened.

Fed just gave us an advantage

Announced that interest rates will stay close to 0 until 2013.
Market is loving it. Thanks Ben!

I actually agree that

I actually agree that investors have never relied on a AAA rating re US Treasury debt. US Treasuries have been at the core of financial algorithms/derivatives/models (and thus markets) as the "risk-free yield" solely because the UST market is highly liquid and price stable and has a monopoly to create dollars. Ratings agencies don't care about how the Treasury and Fed have debased the dollar itself - even though that is an insidious form of default.

But you are being a bit disingenuous here - to claim that the rating is basically irrelevant - and then to cite some EJ Dionne rant about the "outlandishness" of the rating change.

re borrowing simply because

re borrowing simply because interest rates are low

That is why we are in this mess. Whatever govt borrows is perpetual debt. It is NEVER paid back and hasn't been since Calvin Coolidge and Andrew Jackson. It is merely rolled over - at some new interest rate in the future.

Lowering the "hurdle rate" for an investment to zero - merely because short-term rates are zero - means that some future generation that doesn't have low short-term rates will be condemned to eat the loss on that horrible investment. Servicing that debt load will permanently cripple the economy and when interest rates rise, those sub-optimal investments will be exposed as bubbles.

Thinking that long-term rates are low - merely because the Treasury is funding everything short-term - is another guaranteed disaster. A currency crisis is not something the US should be messing with simply because some pols are deluded enough to think they can create productive "jobs". It is potentially wrecking the economy for generations - merely to win some soundbite and protect their flank in the next election.

Does DC even have the capability of learning? Has DC completely forgotten that the popping of the housing bubble is what got us here??? What on Earth makes them think that blowing another bubble is going to work? Isn't the definition of insanity doing the same thing over and over again and expecting different results?

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