S&P Downgrade Of US Government Debt Was A Mistake

by Mike Holman

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The big news this weekend in investing circles was the announcement that Standard & Poor has lowered the US Government Debt rating from AAA to AA+. This is the first time in 70 years that US debt hasn’t been rated triple-A. The other two major rating agencies Fitch and Moody’s kept their rating at AAA.

The United States has some economic problems, but there is no danger of it defaulting on its debt.  Even if the recent “debt ceiling” debacle hadn’t been resolved, it is extremely unlikely that any interest payments on U.S. debt would have been missed.

The reasons why U.S. debt is safe is because they still have the largest economy in the world and they have plenty of capacity to raise taxes. Not only is the U.S. not broke, they aren’t anywhere near close to being broke.

Part of the reason given for the downgrade was that recent debt ceiling agreement will not reduce the deficit enough over the next decade to satisfy S&P. The problem with this logic is that S&P is extrapolating current events fairly far in the future and concluding that things won’t get better. The U.S. might not be going in the right direction in terms of finances, but there is plenty of time for the American government to turn things around, especially if they can raise taxes. Can the Americans get to the point where their debt ratings should be downgraded?  Absolutely – but they just aren’t there yet.

Will the markets crash on Monday because of the downgrade?

I’m hoping so – only because I’m looking to make some equity purchases and lower prices would please me greatly.  However, I doubt the downgrade will affect the market significantly.  The reality is that whatever is good or bad about the U.S. government’s finances will be the same on Monday as it was on Friday.  The downgrade won’t change very much. In theory, it’s possible that government borrowing rates will increase, but that is not certain.  If U.S. treasuries remain as a “safe haven”, borrowing costs will not increase at all. The reality is that there aren’t many other “safe haven” options for large investors.

On the other hand, the stock markets have been trending down lately (especially on Thursday), so perhaps the downgrade will set off a stampede for the exits.

I’m predicting a flat U.S. stock market on Monday.  Please note that I’ve assigned a probability of 51% success for that prediction.  :)

What’s your prediction for the Monday stock trading session? 

 

 

 

 

 

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{ 12 comments… read them below or add one }

1 Echo

A post on a Saturday? Whaaaat?

I’m not sure what to think about the downgrade. Sure, the U.S. has the capacity to raise taxes, but it seems like the politicians are more interested in winning elections than they are about making any real reform.

Obama was supposed to be the change agent that they needed to get the U.S. back on track, but he’s obviously frustrated with how Washington really works.

As for the stock market, my prediction is a 200+ point drop on Monday (just so you can go shopping again).

2 cashflowmantra

I think the markets are going to suffer for a while and that a re-test of 2008 lows are not out of the question. Sitting back and watching for a month or two may not be a bad idea. I am not making any major changes at this point.

3 Rachelle

Markets are not extremely rational… I say down probability 99% :)

4 Gary

Contrary to your post, I think the downgrade is long overdue, but I place no particular faith in any of the rating agencies. These were the same so-called experts that gave top ratings to the garbage peddled by investment banks in recent times. Puts them fairly low on the credibility scale in my books.

All that aside, what is being rated here is the ability of the American political class to recognize that they have a huge problem that has to be fixed with policitally and financially unpalatable measures (entitlement cuts, broaden the tax base, increase taxes to name a few). You are right in that the Americans have the wealth to get themselves out of this mess, but they lack the willingness to do what is needed. The negotiated spending cuts over 10 years accomplish nothing – it’s just smoke and mirrors. Unless the Americans close the budget gap in the next fiscal year or two, the more their issuing of new debt begins to resemble the biggest and most widespread Ponzi scheme one can imagine …. constantly borrowing more to pay off the early investors. The pain that closing the gap will cause is going to be hard for America to swallow, but the alternative will have far-reaching implications for those of us in the rest of the world.

5 Mike Holman

@Echo – My Saturday nights aren’t what they used to be. :)

6 Kevin

Hi Mike, small correction is that the downgrade was to AA+ not AA. I agree with the rest of your article – very sober look at what should be the situation on Monday. However, I can’t help feeling that there will be a fair amount of selling on the markets come Monday morning and stocks will probably test some lower levels this week.

7 Mike Holman

@Kevin – Thanks, I corrected the article.

8 My University Money

The market has clearly dictated that American Treasury Bills still have the confidence of the broader economy, I’m not worried about the cheap publicity stunt downgrade as much as I am about the Euro guys and their debt disasters (most notable Italy).

As a side note, after going on a recent reading spree of Michael Lewis’ books I put no faith in the ratings agency and I’m 90% (just to get in the spirit of assigning percentages) that this downgrade was just to get Standard and Poor’s name in the paper a bunch of times and they accomplished their goal flawlessly.

9 Sampson

I predict the markets will be down ;)

10 Mike Holman

@My Uni $$ – I agree, I think Europe is in worse shape than the US (regardless of what S&P thinks).

@Sampson – Can I invest my money with you? ;)

11 Echo

Ok, Mike…what do I win ;)

12 Mike Holman

@Echo – You win a free subscription to my newsletter. ;)

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