Monday, August 8, 2011

A Few Comments about that Ratings Downgrade

There is not much to say about the S&P action in addition to what has already been said, but here are a few comments for whatever they are worth.

In one sense, the downgrade is ridiculous. Does anyone believe that the U.S. Treasury is a worse credit risk than Microsoft, Automated Data Processing, Exxon, or Johnson & Johnson, all still rated AAA? If somehow one can imagine a scenario in which the U.S., borrowing in its own currency, cannot pay interest on its debt or roll it over, how good would the debt of any U.S.-based companies be in that scenario? Nevertheless, S&P has said it is not currently considering a downgrade to these AAA-rated companies.

In another sense, the threat of default on the debt for political reasons does give one pause. I did not think that would happen, and neither did the market, based on bond prices. Brad DeLong summed it up well, when he wrote that "default was never in the cards, at least not with lawyers at the president's disposal 10% as inventive as those who claim that we are not engaged in 'hostilities' in Libya." That is apparently what most market participants believed.

But if default on the debt was unlikely, or extremely unlikely, to happen, the apparent willingness of some politicians, luckily a minority of the House majority, to cause the U.S. to default on its debt should cause an observer wonder about U.S. politics. Yesterday, the Washington Post quoted Representative Jason Chaffetz (R-Utah) on this point: "'We weren't kidding around, either,' [Chaffetz] said. 'We would have taken it down.'"

There is something deeply wrong with the current state of our politics when people in a position of responsibility make statements like that.

With respect to market movements as I write this midday (Eastern Time), the U.S. and world stock markets have fallen, as one might expect given the uncertainties about the European situation, the economic outlook, as well as the downgrade. However, yields on Treasury securities have been falling, which indicates that they are still viewed as a safe asset to run to when the global economy is shaky.

As for S&P, its record is being examined and roundly criticized, and its action may serve to accelerate a movement, already underway, among regulators to stop relying on credit ratings of "nationally recognized statistical rating organizations." The other two major rating agencies cannot be pleased.

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