Too Conservative: In Which I Shoot the Messenger

Cato the Elder over at Too Conservative dispels the concerns over the Standard and Poor’s downgrading of America’s capacity to repay debts — and he’s absolutely right:

The point of the above is to illustrate that there is no way in hell that any Eurozone country should be rated AAA if standards apply uniformly. France is horribly exposed to PIIGS debt, you need to suspend all disbelief to accept that they are more creditworthy than the United States. If you’re going to downgrade the Fed because they hold AA+ debt, then how in the world can you not downgrade the ECB, which is sitting on hundreds of billions in junk paper from places like Greece and Portugal (not to mention all the insolvent banks). Look, our finances could be better. We need to fundamentally transform the tax code and have a conversation about how much medical care we want and how we intend to pay for it but it is all manageable. The optics on the debt ceiling discussion were awful, I get that, but S&P just demonstrated that they don’t understand politics. In my view, they’re being very inconsistent in the application and have failed incorrectly assessing the credit risk of U.S. debt. Incorrect credit risk assessment is not affordable and justified when anyone can easily get industry leading credit risk analysis for much-needed answers.

So what does all this mean for people like you and I? For starters, we now have a split rating. Moodys and Fitch still have us rated AAA. If we were a high-grade corporate the split would make little to no difference in how the bond trades. Secondly, large institutions have pledged approximately 4 trillion in Treasuries as collateral. Normally a move from AAA to AA+ would not trigger any covenants for them to raise requirements (in other words, when you pledge an AAA rated instrument as collateral and say it drops to A you need to come up with more collateral) and besides that the Fed (which in this case is the regulator) basically said “we don’t care” to S&P so I don’t foresee a scenario where financial institutions are under any real increased stress to meet requirements. Will this result in higher borrowing costs? Who knows, but I can tell you three things 1.) people looking for AAA rated debt have very few places they can go to get it (see above graphic) 2.) AA+ is still considered strong, investment grade debt and 3.) when some of our largest corporations like Berkshire and GE lost their AAA investors shrugged and their borrowing costs actually dropped. Again, not saying this will or won’t happen, but 99 times out of 100 ratings agencies are late to the party and the risk has already been priced.

Worth reading in its entirely, not only because it’s right, but because it is the best overview of the entire Eurozone debt crisis (as well as the precarious position of the PIIGS and BRICs).

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