Downgrade
Posted: August 5, 2011 Filed under: Economy, U.S. Economy, U.S. Politics | Tags: Standard&Poor's downgrade 28 CommentsRating 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.
Krugman on the downgrade:
Geez, how can these companies or whatever these rating agencies are have so much control over the global economy? How do these people get these jobs?
We’ll find out. Youngest daughter wants to get an internship there.
Much as the environment selects for the organisms most adaptable to change, middle-management selects for the people (and I use this term loosely) who are best able to schedule meetings, delegate any and all work to underlings, and generally CYA.
Once again, Krugman hits it out of the park. I’ll post this again here.
Is Standard and Poor’s Manipulating US Debt Rating to Escape Liability for the Mortgage Crisis?
That’s Hamshear’s take, isn’t it?
This is a bit off-topic, but I often wonder if Krugman thinks that babies with colic and the fact that six year-olds don’t grow up to astronauts and/or fairy princesses is the fault of “extremist Republicans.”
Huh?
Krugman blames Republicans for absolutely everything. There’s nothing bad in his world-view which is not caused somewhere, somehow, by a Republican.
Did an airplane fall from the sky? Republicans did it.
Did Fluffy get hit by a car? Probably being driven by a Republican.
Jersey Shore? Probably produced by a Republican.
Et cetera ad nauseum.
did “B” get his/her feelings hurt????
Not sure where you got that one from… :-p
Dak, whatd you think of this one:
Economic Hostage Taking, Take Two | Crooks and Liars
Boehner’s Folly Leads To S&P Downgrade of US Debt | ThinkProgress
US stripped of AAA credit rating by S&P as agency blames political weakness | World news | guardian.co.uk
I think we’ve all shorted the Democratic Party here now. lol!!
I bet against the US around then too. I’m not sure that’s it exactly. I think they’re just another cog in the wheel of financial market stupidity, frankly. They’re all in it for the game. I used to work with millions of dollars at one time, the numbers become meaningless after awhile. It’s about the win and nothing else.
It is just something, reading all these articles, and then reading the comments of “people” about what it all means. See, it is causing me to write sentences that don’t even make sense.
My best guess is that they think long term deficits will be really bad because the Republicans will force BO to extend all the Dubya tax cuts again in the name of saving the economy.
But, i’m just a simple economist on a bayou. What do I know?
You aren’t a simple economist on the bayou, you are dakinikat the great. 😉
These are the kinds of days when I wish I followed my kid dream of digging around in the Egyptian pyramids and being an archaeologist.
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
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.
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.
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.
Makes me glad that I’ve been ignoring the news.
Can we just appoint someone Caesar and get it over with already?
http://dmarron.com/2011/08/05/five-things-you-should-know-about-the-sp-downgrade/
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.
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.
NOTE: The young investor above got screwed in the financial market, but nobody made him push those buttons.