Downgrade

Rating agency Standard & Poor’s downgraded US debt from  AAA  to  AA+.  Additionally, the company  warned of more possible downgrades in the future because of political and economic uncertainty. This basically means that I have to tell students to draw big red lines through all of their asset pricing formulas that tell them to use US treasuries as the world’s base risk free rate.  I can only imagine that when the FMA meets in Denver in October that the big discussion will be should Australia, Canada or France now be considered the rate upon which all else is based?

The downgrade and negative outlook came late on Friday night, after news surfaced of a furious rearguard attempt by the White House to convince S&P that its calculations were flawed.

The move shifts long-term US government debt into the same level as Britain, Japan and other countries, but below that of Canada, Australia and France. As a rule, a lower credit rating means higher borrowing costs for debtor nations. But because of the size of the US and its deep capital markets, it remians to be seen what impact the move will have when financial markets reopen on Monday.

Republicans were quick to highlight the downgrade – the first in modern US history – as a humiliation for President Obama. But S&P’s statement explaining the move blamed both parties for the US fiscal mess – and had harsh words for the Republican party for ruling out any taxes increases.

“We have changed our assumption … because the majority of Republicans in Congress continue to resist any measure that would raise revenues,” S&P said.

S&P also said the budget savings agreed by Congress at the start of the week were too feeble, and blamed political weakness and instability for triggering the downgrade:

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.

The credit rating agency also said the outlook on its long-term rating was negative, warning that it could lower the long-term further rating to AA within the next two years “if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume”.

Standard & Poor’s has suffered a good deal of confidence downgrade since its ratings of Credit Default Swaps in the mortgage meltdown proved less than stellar. Other raters are still considering a similar move.

U.S. Treasury bonds, once undisputedly seen as the safest security in the world, are now rated lower than bonds issued by countries such as Britain, Germany, France or Canada.

The outlook on the new U.S. credit rating is “negative”, S&P said in a statement, a sign that another downgrade is possible in the next 12 to 18 months.

The impact of S&P’s move was tempered by a decision from Moody’s Investors Service earlier this week that confirmed, for now, the U.S. Aaa rating. Fitch Ratings said it is still reviewing the rating and will issue its opinion by the end of the month.

“It’s not entirely unexpected. I believe it has already been partly priced into the dollar. We expect some further pressure on the U.S. dollar, but a sharp sell-off is in our view unlikely,” said Vassili Serebriakov, currency strategist at Wells Fargo in New York.

“One of the reasons we don’t really think foreign investors will start selling U.S. Treasuries aggressively is because there are still few alternatives to the U.S. Treasury market in terms of depth and liquidity,” Serebriakov added.

S&P’s move is also likely to concern foreign creditors especially China, which holds more than $1 trillion of U.S. debt. Beijing has repeatedly urged Washington to protect its U.S. dollar investments by addressing its budget problem.

The downgrade could add up to 0.7 of a percentage point to U.S. Treasuries’ yields over time, increasing funding costs for public debt by some $100 billion, according to SIFMA, a U.S. securities industry trade group.

This move could send a signal to the market to increase interest rates that may trigger the Fed to act in some way.  Given that monetary policy is already at the zero bound and serious attention needs to be paid to fiscal policy based in reality, I’m not sure at this point if a QE3 from Helicopter Ben would even help at this point.  Most corporations are profitable and liquid now.  If anything, higher interest rates will further stymy consumer spending and borrowing.

Some folks believe that the S&P move was meant to pressure the Obama administration into reconsidering new regulations that will impact rating agencies.  Again, rating agencies were part of the collapse of the financial system in and around 2007-2008 when they inappropriately rated many exotic instruments to be highly safe.

Welcome to the new reality in the age of the decline of the American Empire. Hold on to your seats. It’s going to be a bumpy ride.


28 Comments on “Downgrade”

  1. dakinikat says:

    Krugman on the downgrade:

    On one hand, there is a case to be made that the madness of the right has made America a fundamentally unsound nation. And yes, it is the madness of the right: if not for the extremism of anti-tax Republicans, we would have no trouble reaching an agreement that would ensure long-run solvency.

    On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

    Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.

    More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation. The agency has suggested that the downgrade depended on the size of agreed deficit reduction over the next decade, with $4 trillion apparently the magic number. Yet US solvency depends hardly at all on what happens in the near or even medium term: an extra trillion in debt adds only a fraction of a percent of GDP to future interest costs, so a couple of trillion more or less barely signifies in the long term. What matters is the longer-term prospect, which in turn mainly depends on health care costs.

    So what was S&P even talking about? Presumably they had some theory that restraint now is an indicator of the future — but there’s no good reason to believe that theory, and for sure S&P has no authority to make that kind of vague political judgment.

    In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.

    So this is an outrage — not because America is A-OK, but because these people are in no position to pass judgment.

  2. Minkoff Minx says:

    Dak, whatd you think of this one:
    Economic Hostage Taking, Take Two | Crooks and Liars

    Standard and Poor’s has downgraded US Treasury Bonds from AAA to AA+. They claim the downgrade is based on the GOP’s refusal to raise revenues. Maybe. But I doubt it.

    The first question I have is which hedge fund managers stand to profit. That’s an answer I want right now. Not ten months from now. NOW. On July 25th, someone placed a ONE BILLION dollar bet that our credit rating would drop. It’s time for them to be identified.

    It’s time for us to name those profiting from the tea party hostage takers, and know they are us. I am tired of the manipulation. The tea party is rejoicing over this. They believe they will break Medicare and Social Security by breaking the country. If ever there was a time to stand in the streets, in our communities, in our towns and call for them to be held to account.

  3. dakinikat says:

    understatement of the year:

    TheEconomist The Economist
    In an increasingly volatile and overvalued investment environment, cash seems to be the asset class of choice http://econ.st/nYR46r

  4. madamab says:

    I have a lot of trouble with what the “progressives” are pushing. It seems to me that they’re saying, “Well, S&P’s is corrupt and full of sh*t, and anyway it’s all the Tea Party’s fault, so this really isn’t as big a deal as people are making it out to be.”

    I completely agree that S&P’s is a corrupt mess and full of sh*t, but it’s not as though they did this in a vacuum. The debt deal is a disaster for the US economy. It will cost us 1.8 million jobs which we cannot afford to lose. The US is not behaving like a financially sane country and frankly, we are not going to be a good investment until we take unemployment seriously and start creating some jobs. Everyone who knows anything about the economy, including Dakinikat and many other reality-based economists, knows this to be true. Our government is literally burning our country down and dancing in the flames.

    • B says:

      I should probably wait until tomorrow to type this, but what the hell, eh? –

      The thing about the “debt deal” is that it’s mostly a sham. The cuts are over ten years, the largest cuts are at the tail end of that decade, and there’s absolutely nothing preventing future congresses from simply ignoring it.
      The GOP AND the Democrats (and this isn’t just the fault of those wicked, naughty “Republican extremists,” so kiss it Krugman!) (heh) are hoping that no-one notices that nothing is actually going to be cut, with the possible exception of social services which, while it would have the lovely and ironic effect of causing lots of nasty-tempered, rude bureaucrats to have to petition their former co-workers for unemployment benefits, would also probably result in a dozen or so metro areas getting torched.

      • dakinikat says:

        You’re missing the major point. There’s an unconstitutional entity called a super congress that’s been delegated to make tough decisions that congress won’t do … they’ve placed the wars off limits and the appointees to the super congress are likely to gridlock which causes this series of drastic cuts that are based on no rhyme or reason.

      • B says:

        Makes me glad that I’ve been ignoring the news.
        Can we just appoint someone Caesar and get it over with already?

  5. dakinikat says:

    http://dmarron.com/2011/08/05/five-things-you-should-know-about-the-sp-downgrade/

    S&P downgraded U.S. debt not only because of the deteriorating fiscal outlook, but also because of concerns about America’s ability to govern itself. It said:

    The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

    We have Grover Norquist and the Mitch McConnell to thank for this.The Tea Party lit the bonfire but they didn’t hold the matches.

    • B says:

      I’d strongly prefer brinkmanship and gridlock to the bipartisan screwing that we would otherwise get. The less Congress can get done, the better for the rest of us.