Since 1917, the United States have been an excellent student. Unfortunately, that nerdy-organized-well behaved student has hit the college years, when there is a negative effect of the parties on the grades. (You are lucky if you skipped that period). S&P, the New-York based credit-rating agency (CRA), has downgraded the sovereign debt securities of the United States from AAA to AA+ on August 5th 2011, which still makes the country’s reputation very strong, but not the strongest.
What is a CRA?
Along with two other major credit-rating agencies (Moody’s and Fitch), Standard & Poor’s is a company made of analysts, economists and various experts that give “grades” to reflect the market value of stocks and bonds. Investors often use them as a reference for the probability of default or creditworthiness of a particular security. S&P’s downgrade of the last couple of days isn’t much about the risk of default of the United States. Obviously a country can’t go bankrupt like Nortel did. In a last resort, they can print money, at the cost of making it worth more than the paper it’s printed on. They can also raise taxes, spend less, and accept the downfall. The question is: are they willing to pay off their debt? It is more about the lack of stability and predictability of the politics that the downgrade happened. No one seems to have the guts to take some serious action about the debt, blaming it on other presidents, Republicans, Democrats, homeless, sick, aliens… But neighbors, don’t give up! You still have Moody’s and Fitch’s rating at AAA. At the end of the day, a tax cut will be followed by a tax increase in the future. The solution to the nation’s debt is thus not that hard to figure out as it is to implement. “Vote for me as I slash your services and increase your prices” 2012 slogan does not sound very appealing to politicians.
It’s a strong message what S&P is sending to the United States, but how serious is it and what about those financial products back in 07?
After a 2-trillion calculation error and helping create the housing bubble that almost destroyed the US economy by giving the rating of AAA to junk bonds, it’s very hard to take them seriously.
Also, there must be some conflict of interest among these rating companies since they get paid by businesses to be rated. The loss of credibility of the CRAs may as well increase asymmetric information in financial markets, making them less able to allocate credit (maybe positive in this case?). In theory, as a direct effect, the downgrade should lead to an increase in interest rates, making the cost of borrowing higher and the incentive to save higher. But will it be the case? Are governments, investors and consumers really concerned about these ratings? No one really knows. As young professionals let us do two things, hope USA does not double dip and be very proud
C-AAA-NADIANS.