Downgrading from S&P
I was doing volunteer at the Hong Kong International airport during the weekend and couldn’t update my blog here. This is the piece of news I selected for the day when I was browsing some news during my break.
By DAMIAN PALETTA and MATT PHILLIPS
A cornerstone of the global financial system was shaken Friday when officials at ratings firm Standard & Poor’s said U.S. Treasury debt no longer deserved to be considered among the safest investments in the world.
S&P downgraded the U.S. government’s AAA sovereign credit rating, an unprecedented action that could send shock waves through the global financial system. WSJ’s Money & Investing Editor, Francesco Guerrera, reports.
S&P removed for the first time the triple-A rating the U.S. has held for 70 years, saying the budget deal recently brokered in Washington didn’t do enough to address the gloomy outlook for America’s finances. It downgraded long-term U.S. debt to AA+, a score that ranks below more than a dozen governments’, including Liechtenstein’s, and on par with Belgium’s and New Zealand’s. S&P also put the new grade on “negative outlook,” meaning the U.S. has little chance of regaining the top rating in the near term.
The unprecedented move came after several hours of high-stakes drama. It began in the morning, when word leaked that a downgrade was imminent and stocks tumbled. Around 1:30 p.m., S&P officials notified the Treasury Department that they planned to downgrade U.S. debt and presented the government with their findings. Treasury officials noticed a $2 trillion error in S&P’s math that delayed an announcement for several hours. S&P officials decided to move ahead, and after 8 p.m. they made their downgrade official.
S&P said the downgrade “reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” It also blamed the weakened “effectiveness, stability, and predictability” of U.S. policy making and political institutions at a time when challenges are mounting.
“A judgment flawed by a $2 trillion error speaks for itself,” a Treasury representative said.
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It’s possible the blow in the short run might be more psychological than practical. Rival ratings firms Moody’s Investors Service and Fitch Ratings have maintained their top-notch ratings for U.S. debt in recent days. And so far, U.S. Treasury bonds have remained a haven for investors worried about the health of the U.S. economy and the state of Europe’s debt crisis. The pre-announcement could further undermine the impact of the downgrade.
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But the move by S&P still could serve as a psychological haymaker for an American economic recovery that can’t find much traction, and could do more damage to investors’ increasing lack of faith in a political system that is struggling to reach consensus even on everyday policy matters. It could lead to the prompt debt downgrades of numerous companies and states, driving up their costs of borrowing. Policy makers are also anxious about any hidden icebergs the move could suddenly reveal.A key concern will be whether the appetite for U.S. debt might change among foreign investors, in particular China, the world’s largest foreign holder of U.S. Treasurys. In 1945, foreigners owned just 1% of U.S. Treasurys; today they own a record high 46%, according to research done by Bank of America Merrill Lynch.
Late Friday, federal regulators said the downgrade wouldn’t affect risk-based capital requirements for U.S. banks—the cushion banks must hold to protect against losses. The Federal Reserve, Federal Deposit Insurance Corp. and other federal banking regulators said in a statement the lowering “will not change” the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government or government agencies.
Because S&P left the U.S. short-term credit rating unchanged, the downgrade is unlikely to have a big impact on money market funds that own U.S. Treasury bills.
Some investors believe Treasurys will remain a safe place in a volatile world, even without a solid triple-A credit-rating. Others believe the U.S. will be forced to pay higher interest rates, say about 0.5 percentage point higher, simply because they are seen as being slightly riskier than before. While only a slight gain, such a jump would increase the cost of a wide array of debt, from a home mortgage to the trillions of dollars in debt carried by the U.S. government itself.
Lessons from other countries, such as Canada and Australia, suggest it can take years for a country to win back its AAA rating. At the same time, the economic impact of past downgrades has tended to be larger when multiple firms move to rate a country’s debt as riskier, as opposed to a single firm acting unilaterally.
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S&P officials acknowledged the error Treasury pointed out but didn’t believe it was so significant. It was a technical error, though it could have serious implications. It concerned the future ratio of U.S. debt to the size of the economy, with S&P officials projecting a larger share than many experts.
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Recent demographic and economic changes, in particular the aging population and ballooning health-care costs, have made the long-term U.S. picture an ugly one, a problem exacerbated by a deep recession, which cut tax receipts and prompted a flood of fresh debt-financed spending.
Forging an agreement to tackle these problems has been elusive, with bitter partisan disagreements about tax policy and entitlement programs such as Medicare taking center stage.
So far, economic turmoil in Europe and other parts of the world has continued to drive investors toward Treasurys, sparing the U.S. from a price usually paid by countries that can’t get a handle on their debt problems. The phenomenon has kept interest rates paid on government debt very low, making it relatively inexpensive for the Treasury to finance the government’s large deficits.
Chloe Sha 