S&P: from triple-A to double-A+
By: La Septieme Wilaya
S&P (Standard & Poor’s) credit rating agency has downgraded the credit rating of the United States from Triple-A to Double-A+ rating. Is this downgrade warranted from a purely economic perspective? It is my opinion that this decision of downgrade is not warranted at all economically, notwithstanding S&P’s methodology of calculating US government bond rating.
In its press release, S&P argues that the reasons for downgrading US bond rating are not so much linked to the economic outlook or the long term economic strength of the United States, but to its political outlook:
More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutionshave 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,” the statement continues.
This is not an economic evaluation of the outlook of the country, but a political evaluation of the current political climate. Moreover, this is the first time that a credit rating agency has based its rating on the evaluation of the political climate, not matter how bad that climate is. What they are arguing is that the political climate is so bad that it might threatened the full faith and credit of the US. This is one of the most ridiculous assessment i have ever read.
So what does a double-A rating means? Ratings are used as a proxy to determine the financial health of corporation that investors may not know much about. However, everyone knows about the health of the US economic outlook and US government. Moreover, now that the debt ceiling debate has passed and the bill has been signed, no one really thinks that the US is going to default any time soon. We have already noticed that some money market funds have taken steps to loosen their rules around debt ratings to allow higher holdings of US debt in the event of a downgrade (this was clear during the debate about raising the debt ceiling). In addition, double-A rating is still a very high rating, and double-A corporations have statistically identical performance to triple-A ones. The most recent example is when S&P downgraded Japan’s debt to double-A-, and markets more or less didn’t care about that and kept their movements pretty identical to pre-downgrade rating.
Moreover, the other two rating agency, Moody’s and Fitch, have both maintained their triple-A rating of the US government bonds. So, it is safe to argue that the good-standing of the United States as a borrower and a country that honors its debt is still intact. Putting all this together, we can argue that S&P, who by the way has a pretty awful track record as far as grating triple-A rating to junk stocks, junk mortgages, derivatives, and corporations, is making a political decision and move here. The question is why. Is there a partisan political play here for a credit rating agency? If so why?
Finally, it is unclear right now whether this downgrade will drive a huge sell-off when markets open Monday morning. If so, another layer of panic will take hold affecting greatly the economic outlook of every country, and the possibility of double-dip recession could not be totally overlooked. In a panicky market place, there will not be any country safe. Everyone will lose value and will probably see its interest rate increase. If no major sell-offs take place (and i am betting on a mild reaction since all the economic data have already been there for months now and there is no surprise hidden anywhere), market will find some kind of precarious equilibrium between what is happening in Europe and in the U.S. But it is hard to overlook the low blow that Obama has been dealt these last couple of months. As i am sitting here and writing this, Obama does look more and more like a one-term president.