AAA or AA: Important for Choosing Batteries Not for Our Financial Future

Standard and Poor's has warned that there's a 50% chance it would downgrade the credit rating of the United States of America from its once-untarnished AAA perch to a Spain-like AA.  It seems that the credit rating agency and its peers including Moody's are finally concerned about the creditworthiness of the US, even with a debt ceiling compromise.  And they are looking for firm government commitments to large cuts in spending, perhaps as large as $4 trillion.  Or else.

First, what took them so long?  Second, who cares?  After all, it was once the case that S&P and the other ratings agency declared Freddie and Fannie mortgage obligations to be AAA as well.  We might forgive their incompetence and conflict-laden corruption if they hadn't been a major agent in the mortgage meltdown disaster of 2008 and all that it engendered, from TARP to the 2009 stimulus and from QE 1 to QE 2.  But who, at this stage in our country's path to insolvency and currency degradation, is naive enough to take any proclamation by a rating agency seriously?

The opportunity to downgrade our debt for maximum effect has long since passed.  A downgrade might have riveted our attention had it come in January 2010 a year after the stimulus package added $860 billion to our debt but led to no rise in employment levels therefore providing no new source of organic growth to offset Obama's added debt.  Or perhaps a downgrade might have been welcome on March 22, 2010, the day after ObamaCare passed, promising to add another $1 trillion to the national debt.  Maybe a downgrade was appropriate last Friday, completely unrelated to the debt ceiling negotiations, but rather reflecting the downward revision in gross domestic product to under 1% for the first half of 2011.

Instead of enduring another dead-boring press conference presided over by Obama, Reid, or Boehner, S&P, Moody's, and Fitch should have scheduled their own press conferences on stages festooned with black bunting.  That might have helped rouse the country from its slumber of dependency.

But even in less turbulent economic times, downgrades by the ratings firms have a mixed predictive history.  Tom Lauricella of the Wall Street Journal cataloged the effect of agency downgrades on stock, bond, and currency markets, in several countries with original AAA ratings.  In Australia in 1986 and Canada in 1995 the major indices rallied after the downgrade.  And in Australia the dollar rallied as well, though in Sweden in 1991 the krona crashed after the downgrade.  Clearly a ratings agency downgrade is hardly a death knell, and each unhappy country is unhappy for its own reasons.

Of course, the US is not Australia, Canada, or Sweden, at least not yet.  It possesses the world's reserve currency and the deepest, most liquid bond markets.  So a US debt downgrade by any of the major ratings firms might cause a reflexive sell-off in US financial assets.  But then again, perhaps the opposing reflex will prevail.  Investors might panic because Obama has dragged us down from our once-exalted and exceptional heights.  Or, investors might be temporarily consoled that with the downgrade will come a corrective remedy to our fiscal follies.  We might arrive at the long-awaited recognition that much of our recent affluence was illusory based on excessive debt not on private productivity.  Or maybe S&P will just be ignored, and the wisdom of markets alone will determine how much and at what terms the world will lend to us.  The credibility of the agencies might be so damaged that everyone decides to completely ignore their belated wake-up call.

Indeed, it's our overspending government, underperforming economy, and flagging dollar that pose our major long-term problems, not our ability to borrow based on agency ratings.  An indication of  this came during a dizzying 12-hour period from Sunday night into Monday that first saw the Dow futures up nearly 200 points when a debt ceiling breakthrough compromise was announced and futures markets immediately relieved, soared euphorically only to crash on Monday when a miserable Institute for Supply Management number was reported.  Well below estimates of 54.5%, the July ISM report came in at 50.9%, indicating a manufacturing sector on the verge of contracting.  The real economy trumped the ratings bureaucrats.

Whether or not S&P decides to follow through on their threat of a downgrade (and they might be intimidated to shelve it), a downgrade is among the least of our financial worries.  Our legislative branch seems to believe that adding only $7 trillion to our debt between now and 2020 instead of $10 trillion represents a victory for prudent budgeting.  And even that modest $3-trillion haircut is merely a theoretical or aspirational number.  Nothing can bind a congress in 2018 to follow the will of Americans expressed in 2011.  And that's a more frightening thought than any credit downgrade.

Claude can be reached at csandroff@gmail.com.

Standard and Poor's has warned that there's a 50% chance it would downgrade the credit rating of the United States of America from its once-untarnished AAA perch to a Spain-like AA.  It seems that the credit rating agency and its peers including Moody's are finally concerned about the creditworthiness of the US, even with a debt ceiling compromise.  And they are looking for firm government commitments to large cuts in spending, perhaps as large as $4 trillion.  Or else.

First, what took them so long?  Second, who cares?  After all, it was once the case that S&P and the other ratings agency declared Freddie and Fannie mortgage obligations to be AAA as well.  We might forgive their incompetence and conflict-laden corruption if they hadn't been a major agent in the mortgage meltdown disaster of 2008 and all that it engendered, from TARP to the 2009 stimulus and from QE 1 to QE 2.  But who, at this stage in our country's path to insolvency and currency degradation, is naive enough to take any proclamation by a rating agency seriously?

The opportunity to downgrade our debt for maximum effect has long since passed.  A downgrade might have riveted our attention had it come in January 2010 a year after the stimulus package added $860 billion to our debt but led to no rise in employment levels therefore providing no new source of organic growth to offset Obama's added debt.  Or perhaps a downgrade might have been welcome on March 22, 2010, the day after ObamaCare passed, promising to add another $1 trillion to the national debt.  Maybe a downgrade was appropriate last Friday, completely unrelated to the debt ceiling negotiations, but rather reflecting the downward revision in gross domestic product to under 1% for the first half of 2011.

Instead of enduring another dead-boring press conference presided over by Obama, Reid, or Boehner, S&P, Moody's, and Fitch should have scheduled their own press conferences on stages festooned with black bunting.  That might have helped rouse the country from its slumber of dependency.

But even in less turbulent economic times, downgrades by the ratings firms have a mixed predictive history.  Tom Lauricella of the Wall Street Journal cataloged the effect of agency downgrades on stock, bond, and currency markets, in several countries with original AAA ratings.  In Australia in 1986 and Canada in 1995 the major indices rallied after the downgrade.  And in Australia the dollar rallied as well, though in Sweden in 1991 the krona crashed after the downgrade.  Clearly a ratings agency downgrade is hardly a death knell, and each unhappy country is unhappy for its own reasons.

Of course, the US is not Australia, Canada, or Sweden, at least not yet.  It possesses the world's reserve currency and the deepest, most liquid bond markets.  So a US debt downgrade by any of the major ratings firms might cause a reflexive sell-off in US financial assets.  But then again, perhaps the opposing reflex will prevail.  Investors might panic because Obama has dragged us down from our once-exalted and exceptional heights.  Or, investors might be temporarily consoled that with the downgrade will come a corrective remedy to our fiscal follies.  We might arrive at the long-awaited recognition that much of our recent affluence was illusory based on excessive debt not on private productivity.  Or maybe S&P will just be ignored, and the wisdom of markets alone will determine how much and at what terms the world will lend to us.  The credibility of the agencies might be so damaged that everyone decides to completely ignore their belated wake-up call.

Indeed, it's our overspending government, underperforming economy, and flagging dollar that pose our major long-term problems, not our ability to borrow based on agency ratings.  An indication of  this came during a dizzying 12-hour period from Sunday night into Monday that first saw the Dow futures up nearly 200 points when a debt ceiling breakthrough compromise was announced and futures markets immediately relieved, soared euphorically only to crash on Monday when a miserable Institute for Supply Management number was reported.  Well below estimates of 54.5%, the July ISM report came in at 50.9%, indicating a manufacturing sector on the verge of contracting.  The real economy trumped the ratings bureaucrats.

Whether or not S&P decides to follow through on their threat of a downgrade (and they might be intimidated to shelve it), a downgrade is among the least of our financial worries.  Our legislative branch seems to believe that adding only $7 trillion to our debt between now and 2020 instead of $10 trillion represents a victory for prudent budgeting.  And even that modest $3-trillion haircut is merely a theoretical or aspirational number.  Nothing can bind a congress in 2018 to follow the will of Americans expressed in 2011.  And that's a more frightening thought than any credit downgrade.

Claude can be reached at csandroff@gmail.com.

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