VOL. 126 | NO. 154 | Tuesday, August 9, 2011
New World Follows US Debt Downgrade
By Andy Meek
Here we go again. Markets opened Monday, Aug. 8, with the world irreversibly changed, thanks to last week’s downgrade of U.S. debt by Standard & Poor’s from AAA to AA+. It follows last week’s wild ride for the stock market, which included stomach-churning swings for investors up through Friday, the day S&P issued the press release heard round the world after markets closed.
The first-ever downgrade represents an historic psychological blow to an economy still gasping for air – but experts say it’s not clear what comes next.
According to a recent commentary published by FTN Financial, a division of First Tennessee Bank, “The dollar magnitude of a rating downgrade of the U.S. and its related entities has never occurred before. Projecting how markets might react can’t follow an existing template.”
This moment could have been a lot worse. Since the other two major rating agencies, Fitch Ratings and Moody’s Investors Service, have not changed their AAA credit rating on U.S. debt, FTN Financial chief economist Chris Low said the U.S. may still get to be considered AAA in some circumstances.
That’s because “most investment guidelines stipulate managers can choose any two of the big three rating agencies when considering the rating of a bond – although it goes without saying it would be preferable to avoid a downgrade altogether,” Low wrote in a commentary on the markets.
The country’s major banking regulators have already responded to the downgrade. In a press release following the downgrade, the regulators said their treatment of U.S. Treasury debt and other debt issued by the government won’t change for purpose of capital risk weight.
Last week’s news wasn’t an absolute shock, as a downgrade of some sort had become expected. Among the consequences: eventually, it means higher borrowing costs for the federal government, as well as corporations and consumers.
Yet there are still relatively few assets regarded as safe havens to the degree that U.S. Treasuries are.
“Whoever you are, you want to buy American securities,” said Brent Westbrook, business development officer for Argent Trust Co. of Tennessee.
David Waddell, president and CEO of Waddell & Associates, said last week’s furious round of selling purged a large amount of pessimism in the stock market.
So what does that mean for the days ahead?
“Unclear,” Waddell said. “The downgrade amounts to a non-event, in my judgment. Messages from the (Federal Reserve) and (European Central Bank) will be the market movers. Stocks have gotten cheap. Moves lower from here will require hard justification in the form of bad economic statistics or credit disruption.”
The response in Asian markets will be watched closely. China and Japan hold more than $1 trillion and more than $900 billion in Treasury securities, respectively.
Low wrote that he expected volatile trading when markets opened this week.
“There is quite a bit of cash sidelined in the money markets and in the community bank universe just waiting for higher yields to be put to work,” Low wrote. “On the other side, many repo agreements stipulate triple-A collateral, and there could be some confusion to be sorted out. Because two of the three ratings agencies confirmed the triple-A rating, however, the contracts should still be valid even with Treasury and agency collateral.”
The Dow Jones industrial average fell more than 250 points minutes after the opening bell on Wall Street Monday. It recovered some of those losses, then fell again and was down as many as 375 points in mid-morning trading.
In other early trading Monday, the main stock index fell almost 4 percent in South Korea and more than 2 percent in Japan. European markets opened later and fell, too.
Gold, which investors traditionally buy when they want a safe investment, rose above $1,700 per ounce Monday.
Meanwhile, the big worry about what the downgrade means has to do with the trait it shares with the mortgage meltdown and credit crash of 2008: Then, as now, the U.S. economy has entered a place it’s never been before.
The Associated Press contributed to this report.