Sunday, August 7, 2011

What the Standard & Poor's Downgrade of US Debt Means to You

You've probably heard that Standard & Poor's downgraded US debt.  Even if you don't own a T-Bill, it's bad news for you.   Even if you were a supporter of a reasonable approach to cutting US debt when your congressional representatives were not, you've been personally penalized by a company whose ability to assess risk has been shown to be sadly lacking.
The first part of your bad news is that US debt was downgraded by the same company that rated mortgage backed securities that were backed by dicey mortgages as AAA.  Here's what that assessment means, in their own words.
'AAA' stress scenario.
An issuer or obligation rated 'AAA' should be able to withstand an extreme level of stress and still meet its financial
obligations. A historical example of such a scenario is the Great Depression in the U.S. . . .,(with)  real GDP declined by 26.5%, . . .unemployment peaked at 24.9%, . .  industrial production declined by 47% and home building dropped by 80%. . ., (t)he stock market dropped by 85% ...,(and) deflation of roughly 25%. . . .The 'AAA' stress scenario envisions a widespread collapse of consumer confidence. The financial system suffers major dislocations. Economic decline propagates around the globe.
Over a year ago, I discussed why investors' reliance on these ratings was a significant cause for the financial meltdown.  Ratings agencies, unlike banks and insurance companies, however, bore little public blame for the catastrophic losses. 
Now, how is a reasonable person to interpret what a downgrade on US debt from AAA to AA+ means?  You saw what AAA means.  Basically, Standard and Poor's assured mortgage backed securities investors that the issuers would pay interest to them even if there were a Depression.  Oopsie.
That same company has now said it's possible that US Treasury bills notes and bonds may NOT be repaid even if there is a Depression.  Considering the fact that Congress came within a day of default to agree on a repayment plan, the downgrade may not seem all that unreasonable.
But then, they are the company that gave a AAA to those pesky mortgage securities, aren't they?
That aside for the time being, Standard and Poor's has now rated US debt as AA+.  Here is what a AA means.  Remember, a AA+ is slightly better than this rating.
AA: An obligor rated 'AA' has very strong capacity to meet its financial commitments. It differs from the
highest-rated obligors only to a small degree. 
'AA' stress scenario.
An issuer or obligation rated 'AA' should be able to withstand a severe level of stress and still meet its financial obligations. Such a scenario could include GDP declines of up to 15%, unemployment levels of up to 20%, and stock market declines of up to 70%.
Well, for starters, 2010 US GDP growth was 2.8%.  The first six months of 2011, GDP growth has been .9%.  By my calculations .9% is about 66% less than 2.8%, far worse than15%, and we're still paying.  Unemployment is 9.1%.  S&P thinks unemployment can double, and we'll keep paying.  The stock market, as measured by the S&P 500 Index, dropped by about 50% from summer 2008 to early 2009.  They think we'd keep paying if it had dropped 20% more than it did.
So, it was the THREAT of US debt default, not the inability to pay that caused this downgrade. 
It's up to you whether you think it's appropriate for a ratings agency to consider political shenanigans as a reason to downgrade debt ratings.
But, back to you.  Why do you care?  You're not in DC. 
With this downgrade, those who lend us money, like China, Japan, the UK and countries who export oil to us (in that order), can reasonably charge us more for those loans.  After all, we threatened to default and one of our own ratings agencies said lending us money is riskier than it used to be.
That extra interest we pay is an added expense to our country, making the debt problem worse.  And, with higher interest rates, people who buy houses, borrow money from banks, credit cards, etc., (all of us that don't live on a cash basis) will pay more, too.
All politics is local.  Playing around with the debt ceiling is going to cost you.
So, if your representatives and senators voted against raising the debt ceiling, they are costing you real money.  If they want to actually help you, ask them to use their influence to talk to Standard and Poor's about the wisdom of using politics to rate our debt.