S&P Warns On US Debt. Do We Care?
The Dynamic Wealth Report
April 21, 2011
by Jay Chernoff, Editor
S&P shocked the financial markets this week. They warned of a possible
future downgrade of the US government’s credit rating. This unexpected
news hit equities particularly hard, with major stock indices down over
2% at one point.
It was quite the eye-opener.
But make no mistake, this is far from a cut and dry situation. And
there’s a lot more to S&P’s warning than meets the eye.
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First off, does the US deserve a ratings downgrade?
In a word… yes… technically speaking.
If you consider the country’s debt and the government’s inability to
agree on a solution, then by definition, US credit should be rated
lower. Essentially, if a corporation was in the same boat as the
US, there’s no way their credit would be rated AAA.
In fact, from that perspective, S&P waited far too long to warn about a
possible US ratings downgrade.
So is this a big deal?
It could be.
You see, US debt is considered the closest thing to a risk-free
investment on the planet. Many funds are required to hold a
percentage of their assets in a risk-free investment. If US
Treasuries are downgraded, it’s possible many of those funds would be
required to liquidate their Treasury holdings.
But here’s the thing…
It doesn’t mean these funds would actually make any changes.
While there are 18 other AAA-rated countries, most of them aren’t any
better off than the US right now. Not to mention, the US is still
the world’s biggest economy by a long shot.
More importantly, while equities sold off sharply on the news, US
Treasuries actually went up. People were buying Treasuries not
long after S&P’s warning.
Why would people buy Treasuries when the creditworthiness of the
government is being questioned?
To put it simply, investors don’t believe or trust the ratings
agencies.
In my own words… the ratings agencies are a joke.
Let me share a quote by Michael Lewis from his fantastic book about the
2008 Financial Crisis, The Big Short. I think this
excerpt does a good job of summarizing Wall Street’s view of rating
agency analysts.
“[T]he people who worked at the rating agencies barely belonged
in the industry. If they roamed the halls they might be mistaken,
just, for some low-level commercial bankers at Wells Fargo, or
flunkies at mortgage lenders…”
Plain and simple, the ratings agencies completely dropped the ball with
mortgage derivatives. They didn’t come anywhere close to
accurately rating most mortgage derivative products.
Where were these guys when the mortgage industry was about to implode?
Oh yeah, they were out giving extremely high risk CDOs AAA ratings!
These geniuses were basically saying CDOs were as safe as US Treasuries.
Currently, most CDOs are worthless. But the last time I checked,
plenty of people were still buying Treasuries.
Here’s the truth of the matter… there’s no realistic way the US
defaults on its debt.
As I mentioned above, the US does technically deserve a lower rating.
But, in practice, there’s no way they will default. (There’s one
caveat – if the debt ceiling doesn’t get raised, there could be a real
issue. But, the debt ceiling debate is nothing more than politics…
one way or another, it will get raised when the time comes.)
You see, the US government can print money to make debt payments
whenever they want. In theory, it’s
impossible for them to default.
Yes, printing money can cause other serious issues – namely inflation.
But it’s not S&P’s job to analyze inflation concerns. Their job is to
analyze creditworthiness. And for all intents and purposes, the
possibility of future inflation has nothing to do with the
creditworthiness of a government.
So let me get this straight… the US can theoretically avoid default as
long as they want by printing money. And, S&P doesn’t base its
ratings on inflation risk.
Tell me again why S&P is warning of a downgrade?
I’ll stick with my first answer… the ratings agencies are a
joke.
Look, there may be a host of serious issues facing the US in the coming
months and years. But one of those concerns is not
creditworthiness. The government will not default on its debt
payments. And there’s very little chance their credit rating will
get downgraded. But seriously… who cares what S&P says anyways.
One of the most active ETFs this week is the iShares Silver Trust ETF
(SLV). It’s up over 2.5% today and a whopping 146% over the past year. SLV tracks the performance of silver by purchasing the physical metal. Silver prices continue to soar on high demand for precious metals.
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