America's Crisis Of Confidence Begins

After the close of markets last night, Standard & Poors (S&P) announced that U.S. debt would no longer carry a AAA rating. From Bloomberg's U.S. Loses AAA Credit Rating as S&P Slams Debt, Politics—

Standard & Poors downgraded the U.S.’s AAA credit rating for the first time, slamming the nation’s political process and criticizing lawmakers for failing to cut spending enough to reduce record budget deficits.

S&P lowered the U.S. one level to AA+ while keeping the outlook at “negative” as it becomes less confident Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said yesterday...

“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,” S&P said.

S&P put the U.S. government on notice on April 18 that it risked losing the AAA rating it had since 1941 unless lawmakers agreed on a plan by 2013 to reduce budget deficits and the national debt. It indicated last month that anything less than $4 trillion in cuts would jeopardize the rating.

The downgrade was the final straw in a week which I believe the world will long remember. It would behoove those who can not accept the obvious facts of America's decline to think about what happened last week. Our political "leaders" proved beyond any doubt that they are just as short-sighted, self-serving, dysfunctional and corrupt as I have repeatedly said they are. It's a wonder the U.S. credit rating is not BBB+, or worse.

The stock market fell all week long, with the DJIA losing 10% of its value on Thursday. On Friday, the stock indices went up & down like a yo-yo. Nobody knew whether to buy or sell. For investors, there was nothing to hang your hat on. The endless crisis in Europe seemed to be getting worse, the economy obviously sucks, and everyone knew a downgrade was coming. And then S&P lowered the boom. Those holding equities will have all weekend to think about the safety of their money.

The loss of the AAA is not apparently an immediate disaster. The other ratings agencies, Moodys and Fitch, did not downgrade America's credit rating. And we should bear in mind that subprime junk (mortgage-based securities) was rated by AAA by these agencies in 2008. In US AAA Rating Downgrade: The Important Detail, Forbes columnist Tim Worstall tried to gauge the effects of the downgrade.

In one manner, it shouldn’t have any effect at all. Whatever the rating the US Treasury market is the largest, deepest and most liquid in the world. Further, a ratings agency isn’t in fact determining the likelihood of repayment nor even really the credit rating: with sovereigns, it’s much more true to say that they’re summing up what the wider market already thinks.

So, in this limited sense the move in the rating is simply confirming what the market already believes and markets don’t move on old information, they move on new information.

However, there’s another sense in which this move is potentially seismic.

For there are an awfully large number of Treasury owners out there who are only allowed to own AAA assets. Rather than bore you with the details, just know that many insurance company, pension fund, bank capital, holdings must be in AAA rated securities. So, a downgrade of the Treasury market means that all of these people cannot own these bonds any longer: they’ve got to sell them and go and buy other, AAA rated bonds or assets. So does this presage financial Armageddon?

No, still not quite: for the decision about what is an AAA asset isn’t taken by one ratings agency alone. It’s the average of the three major agencies that matters. As long as Fitch and Moody’s keep their AAA rating then technically the US is still rated AAA. S&P on its own changes pretty much nothing...

... well, what else is there?

Foreigners, that’s what. There are foreign insurance companies, pension funds and so on who are also restricted to AAA assets. It’s up to their home regulators, not the Fed, to decide whether Treasuries (if one of the other two ratings agencies follows suit) still count as AAA securities.

And the answer to that question is as yet unknown.

The immediate financial effects don't matter much. What matters is that somebody with some clout has finally said out loud what everybody with half a brain has been thinking for years—the United States is no longer capable of managing its affairs. America's governance is now so atrocious, so irresponsible, so lacking in accountability, that somebody finally took a very small step toward recognizing our manifest failures. The credit downgrade is a pinprick to America's grandiosity, its hubris, and its sense of entitlement. Americans are surely the most delusional people in the world.

Up until now, it's been extend & pretend, an epidemic of Denial, a disease for which the only cure is a big dose of Reality. Don't worry, the economy has hit a "soft patch". Don't worry, we can see some green shoots. Don't worry, we're in the Summer of Recovery (that was in 2010).

America's crisis of confidence has finally begun.

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[Bill Hicks]

Don't worry, Dave. Paul Krugman is still in denial. Here is a quote from his blog last night:

"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."