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Archive for Sunday, August 7, 2011

U.S. downgrade raises anxiety — but what exactly does it mean?

August 7, 2011

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The real danger from the downgrade of U.S. government debt by Standard & Poor’s isn’t higher interest rates. It’s the hit to the nation’s fragile economic psyche and rattled financial markets.

S&P’s decision to strip the U.S. of its sterling AAA credit rating for the first time and move it down one notch, to AA+, deals a blow to the confidence of consumers and businesses at a dangerous time, economists say.

The agency is “striking at the heart of what makes the global economy tick,” says Chris Rupkey, chief financial economists for the Bank of Tokyo-Mitsubishi UFJ. “It isn’t just dollars and cents.”

A look at this downgrade, and downgrades in general — and what they mean:

Q: What did Standard & Poor’s do?

A: The ratings agency downgraded its rating on the federal government’s long-term debt one level from the top AAA grade to AA+. Long-term debt includes notes and bonds that come due in more than one year.

They have terms ranging from two to 30 years. Short-term debt includes Treasury bills that have terms ranging from a few days to 52 weeks.

The rating on the government’s short-term debt was not downgraded. Of the $9.4 billion in publicly traded U.S. government debt, 72 percent is long-term.

Q: What does a downgrade mean?

A: A downgrade is a warning to buyers of bonds and other debt that the chance that they won’t get their money back has increased, however slightly. In theory, downgrades should lead to higher borrowing costs for the issuer (in this case, the government), since investors demand a higher interest rate if they’re taking a bigger risk.

Q: Does it mean U.S. interest rates will go up?

A: The 10-year Treasury note is considered the basis for all other interest rates, so higher rates on that and other long-term U.S. debt could lead to borrowing costs on everything from mortgages to car loans. That would also make it more expensive for state and local governments, companies and consumers to borrow money.

But it’s not clear that S&P’s downgrade will have an effect on rates. Treasury securities are a foundation of the U.S. financial system and are still considered one of the safest investments in the world. As stocks plunged the last two weeks, the price of Treasurys soared because demand was high, even though investors knew there might be a downgrade. Since yields on debt securities fall as prices rise, the yield on the 10-year note dropped from 2.96 percent on July 22 to 2.39 percent on Friday.

A downgrade could spur a “quick jolt of nervous, knee-jerk selling” of bonds, raising rates in the short term, said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott. But investors are so worried about the economy and need the safety of Treasurys that they could quickly become buyers again.

Q: Wasn’t this what the debt limit agreement in Congress was supposed to prevent?

A: Yes, but S&P sees the agreement as falling short of what’s necessary to fix the nation’s finances. The spending cuts Democrats and Republicans agreed on were relatively modest. More difficult, comprehensive cuts were pushed to the future. S&P also notes that the possibility of new revenue, for instance from tax increases, appears more remote than before. The rancor around the agreement also made it more clear how far apart Democrats and Republicans are. “Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden,” S&P said.

Q: What did the other ratings agencies do?

A: The two other major agencies haven’t taken action yet. Moody’s Investor Service has said it might downgrade the U.S. rating, but its chief economist noted Friday that Treasury securities “are still the gold standard.” Fitch Ratings said last week that the agreement on budget cuts was an important first step but “not the end of the process.”

Q: How many times has the U.S. been downgraded below AAA?

A: Never. The S&P has given the U.S. a AAA rating since 1941. The U.S. and has only faced the threat of a downgrade once. In 1995, when Bill Clinton was president, a similar default loomed and the credit rating agencies warned of a downgrade. At the time, the country had $4.9 trillion in debt — nearly $10 trillion less than now. Once Congress resolved that debt crisis a year later, the credit agencies removed their warning.

Q: How has a downgrade affected other countries?

A: In May 1998, S&P knocked Belgium, Italy and Spain from AAA to AA. A week later, their 10-year rates had barely budged. In some cases, fell. A week after S&P took Ireland’s AAA rating away in March 2009, 10-year rates in that country had fallen 0.18 percentage points.

Q: What other countries have AAA ratings from S&P?

A: Britain, Germany, Australia, Austria, Denmark, the Netherlands, Norway and Finland are among those that have the top rating.

Q: How big is the market for U.S. government bonds?

A: At $9.3 trillion, the U.S. government bond market is massive compared with those of other countries. Daily trading of Treasurys runs at $580 billion, far higher than British gilts ($34 billion) or German bunds ($28 billion), according to a recent study by Fitch.

“I think no matter what happens, Treasurys are the safe haven,” said Dan Greenhaus, chief global strategist at the brokerage BTIG in New York. “No other market is as large or as liquid.”

Treasurys have a solid appeal for the world’s central banks. China’s central bank holds an estimated $1.16 trillion. Japan, the second largest foreign owner, holds $912 billion.

Fitch said the status of the U.S. dollar and the size of the Treasury market are the biggest reasons investors won’t abandon Treasurys soon. The dollar is the global reserve currency, which means a significant amount of global purchases are made in dollars — like toys and computer chips from China, coffee from Kenya, cars from Japan and oil from all over the world. Central banks in other countries therefore hold large reserves of U.S. currency, mostly through Treasury purchases.

Q: How long might it take for the U.S. to regain a AAA rating?

A: Analysts say it could be tough for the U.S. to regain the AAA rating soon especially given its current economic challenges. S&P officials implied that it will take years to see a meaningful change in the U.S. fiscal situation and in the government’s ability to cut the budget.

Comments

Crazy_Larry 3 years ago

Seems like the corporations are controlling the government! LOL! We the People! Get it? Corporations are people too! ROFL!

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Crazy_Larry 3 years ago

John Chambers, S&P Head, Explains Why They Decided To Downgrade The U.S. Credit Rating: http://www.youtube.com/watch?v=p339TWCjYso

Fred Sanford: http://www.youtube.com/watch?v=lMTrth...

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Godot 3 years ago

Does this equivalence mean that the Obama campaign will pick up the tab for his get-out-the-vote-and-rekindle-the-tingle-of-hope-and-change bus tour? Nope. We flat-busted, down-graded over worked taxpayers, you know, the 49% of us who actually pay incomes taxes are paying for Obama's presidential campaign bus tour. It is only right. He was soooooo inconvenienced when he had to cancel his fund raisers to stick around DC and keep threatening to veto any bill that came out of Congress.

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Richard Heckler 3 years ago

The largest obstacles are fear of losing special interest campaign money, guts to terminate Bush tax cuts and backbone to cut off pork barrel corporate subsidies. This crop of 2012 candidates are and will be no different.

Blame USA industry for China. No one forced USA industry to move off shore. We always forget USA industry has been screwing americans and our economy in a big way since 1980.

Blame corp america every day they employ chinese workers over USA workers!

The remedy:

One answer to problems such as this: CUT OFF special interest financing of elections! YES even at the local level.

Our government is always claiming the USA is about democracy. In that case allow the citizens to practice democracy by allowing citizens to vote in these measures come 2012:

Let's demand a new system and vote in Fair Vote America : http://www.fairvote.org/irv/ Demand a change on the next ballot.

Let's have public financing of campaigns. Citizens cannot afford special interest money campaigns for it is the citizens that get left out. Let citizens vote on this issue. http://www.publicampaign.org/

Bribery of elected officials is the most stinky of all bribery!

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Richard Heckler 3 years ago

When will democrats learn four things?

  1. Following the economic direction of Tea Party Neoconservative Christian Fundamentalists frustrates the entire planet.

  2. That government MUST step up to the plate = establish a major 3 year job program that does not include USA industry and USA banks yet will employ millions upon millions. Banks and USA industry DO NOT want to employ Americans.

  3. I want my tax dollars putting people to work making money and creating new economic growth. This is a best bang for the tax buck. Rehabilitate federal highways, rehab sidewalks in every community = healthy for Americans and bring on clean collar employment.

  4. Congress always forget USA industry has been screwing americans and our economy in a big way since 1980.

Retaining Bush tax cuts,not saving $4 trillion and putting forth zero job bills obviously was not the answer.

Neither Tea Party neoconservative republicans nor democrats stepped up to the plate

What was missing from the deal? A budget that would have saved $4 trillion.

Plus Millions of new jobs that would create new economic growth and the “Peoples Budget” that which does everything this country needs:

* Creates good-paying jobs
* Fully maintains our social safety net
* Invests in education
* Ends our costly wars
* Closes the tax loopholes that have made offshoring jobs profitable
* Ends oil and gas subsidies that pollute our country at taxpayer expense
* Creates a national infrastructure investment bank to help us make intelligent investments for the future

The “People's Budget” represents not just common sense; it represents the will of the American people.

What the “Peoples Budget” does very specifically:

http://cpc.grijalva.house.gov/index.cfm?sectionid=70&sectiontree=5,70

http://www.npr.org/2011/04/15/135435883/the-nation-obama-should-fight-for-peoples-budget

http://www.democracynow.org/2011/4/14/while_obama_touts_compromise_with_gop

http://www.thenation.com/blog/159939/fighting-peoples-budget

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just_another_bozo_on_this_bus 3 years ago

Well, that's just brilliant. The whole problem is caused because people who can barely put food on the table aren't paying enough taxes (and pretty much everyone does, in fact, pay taxes.)

Talk about straw men.

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camper 3 years ago

So the other 49% are freeloaders? False. This is a common misconception advertised by certain groups. And these groups leave out federal payroll taxes.

Everyone who gets a paycheck wether it be minimum wage is paying Social Security/medicare taxes. This is found in Box 4 and 6 on your w-2 form.

It is simply false to say that 51% of us are not paying federal taxes. This is only true of Federal Income taxes. Even at that, the reason many do not pay federal income tax is because of a tax code that allows generous itemized deductions such as mortgage interest.

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Crazy_Larry 3 years ago

In a democracy, the majority wins.

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just_another_bozo_on_this_bus 3 years ago

http://krugman.blogs.nytimes.com/2011/08/05/sp-and-the-usa/

S&P and the USA: Right's 'Madness' and Agency's Ineptitude Led to Downgrade by Paul Krugman

NEW YORK - OK, so Standard and Poors has gone ahead with the threatened downgrade. It’s a strange situation.

On one hand, there is a case to be made that the madness of the right has made America a fundamentally unsound nation. And yes, it is the madness of the right: if not for the extremism of anti-tax Republicans, we would have no trouble reaching an agreement that would ensure long-run solvency.

On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.

More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation. The agency has suggested that the downgrade depended on the size of agreed deficit reduction over the next decade, with $4 trillion apparently the magic number. Yet US solvency depends hardly at all on what happens in the near or even medium term: an extra trillion in debt adds only a fraction of a percent of GDP to future interest costs, so a couple of trillion more or less barely signifies in the long term. What matters is the longer-term prospect, which in turn mainly depends on health care costs.

So what was S&P even talking about? Presumably they had some theory that restraint now is an indicator of the future — but there’s no good reason to believe that theory, and for sure S&P has no authority to make that kind of vague political judgment.

In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.

So this is an outrage — not because America is A-OK, but because these people are in no position to pass judgment.

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camper 3 years ago

Bozo. I am also ticked off at the SEC. Where were they? Why did they allow bundled mortgages as tradeable securities? Why do they still allow these securities? Is it not there role to prevent fraud securities, junk bonds, speculation, ponzi schemes etc? Maybe the usefulness of the SEC has expired. It seems WallStreet has found a way to get around them or push them around.

I ramble.

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jhawkinsf 3 years ago

Camper and Bozo bring up interesting points. It seems to me that every time the government imposes a rule of some sort, they then put in a bunch of exceptions. In the tax system, we call them loopholes. In regulations, we call them other things. One of the problems with all these exceptions, one that even Bozo who rarely agrees with me will probably agree with, is that those who are best off are most able to access those exceptions. And they are most able to influence lawmakers who decide which exceptions will exist. It's for that reason I've long advocated a flat tax system. Personally, I think everyone should pay the same percentage. A compromise to that (because I realize that it's a somewhat regressive tax) would be to tax the poor at say 15%, the middle class at say 18% and the wealthy at say 23%. Of course, taxing those groups at different rates are exceptions, the very exceptions that I complained about earlier. While taxing the poor may be objectionable to some, removing the bazillion loopholes that only the very well off can access will set up a system that is more fair.

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jafs 3 years ago

It should be noted that the atmosphere at the SEC may be directly related to the administration in power.

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nut_case 3 years ago

Except USA is on the way down and China is on the way up. China has already said, "The glory days of borrowing are over", so they will be keeping even more money at home and we will be able to borrow less - which will even speed up their rise and our decline.

Our main problem seems to be republicans AND democrats in a race to see who can flush the country down the toilet the fastest. No real solution from either party which actually puts the USA in a fiscally responsible mode - just a bunch of whining and finger pointing from both sides and the general public.

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just_another_bozo_on_this_bus 3 years ago

Actually, only about 1/3 of US Treasury bonds are held by foreign entities, and China is the largest holder among those, with app. 1/4 of them. Meaning that China holds approximately 8.5% of total US bonds.

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camper 3 years ago

"But it’s not clear that S&P’s downgrade will have an effect on rates. Treasury securities are a foundation of the U.S. financial system and are still considered one of the safest investments in the world. As stocks plunged the last two weeks, the price of Treasurys soared because demand was high, even though investors knew there might be a downgrade. Since yields on debt securities fall as prices rise, the yield on the 10-year note dropped from 2.96 percent on July 22 to 2.39 percent on Friday."

We may have dodged a bullet. This is good because if T-Bill rates go up, so will the interest we pay on our debt (which of course much of which will go to our large creditor China).

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Crazy_Larry 3 years ago

Wait a minute! Isn't the S&P one of the ratings agencies that brought down the world's economies by giving AAA ratings to junk derivatives? Yeah, yep, yes they are! This game is rigged!

http://www.youtube.com/watch?v=1depDSULUU8

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jmadison 3 years ago

  1. The Federal Reserve has been buying the majority of the federal debt for the past year, artificially lowering the interest rates on Treasury debt, and pumping up the profits of the big Wall Street Banks.
  2. Goldman Sachs and JP Morgan investment banks sold bundled mortgages that they knew were dross to the public, but were rated AAA by the ratings agencies.
  3. Sen. Dodd and Rep. Frank protected Fannie Mae from any meaningful oversight, and were rewarded with being able to put their name on the Dodd-Frank consumer protection bill.
  4. Fannie Mae is draining about $8 billion per month from the Treasury to prop up their operations.
  5. Bush overspent and Obama has doubled down by increasing the debt.

No Wall Street or Fannie Mae employees have gone to jail.

America has been turned into one giant Potemkinville, and our elite class--politicians, Wall Street brokerages, and bureaucrats-- bear no responsibility. Its a sad commentary on what America has become courtesy of our political class.

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Jayhawk1963 3 years ago

This comment was removed by the site staff for violation of the usage agreement.

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just_another_bozo_on_this_bus 3 years ago

Even this butthead can spot a dittohead practicing the same ole circular logic and argument by assertion.

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Crazy_Larry 3 years ago

http://www.ft.com/cms/af2c4fac-bfc2-11e0-90d5-00144feabdc0.pdf

Page 4, last paragraph of the S&P's report:

"Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act."

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Crazy_Larry 3 years ago

http://www.ft.com/cms/af2c4fac-bfc2-11e0-90d5-00144feabdc0.pdf

Page 4, last paragraph of the S&P's report:

"Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act."

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