8/23/2011 8:08 PM ET
The bungled downgrade of US credit by Standard & Poor's shows just how far financial markets still have to go to understand the risks that remain.
Jim Jubak
On Aug. 5, Standard & Poor's downgraded the credit rating of the United States to AA+ from AAA.
What's happened to the debt of the United States since then?
Treasurys have rallied and sent yields to historic lows. Last week the yield on a two-year Treasury was at 0.19%. The yield on a 10-year Treasury closed the week at 2.07%. That was slightly above the low set on Thursday of 1.97%. That was the lowest yield on the 10-year Treasury since 1950.
Latest on Standard & Poor's downgrades
There's no way to escape a certain amount of schadenfreude. There is pleasure, admit it, in seeing the market thumb its nose at Standard & Poor's, the credit-rating company that got the mortgage-asset market so terribly wrong and helped create the global financial crisis by giving AAA ratings to so much paper that quickly demonstrated it didn't deserve an AAA rating by collapsing in price as the underlying mortgages went sour.
But I wouldn't let the grim pleasure at Standard & Poor's discomfiture become your primary emotional reaction to the rally in U.S. debt markets. That main emotion should be worry. This rally isn't a sign of health in the financial markets.
First, the rally is a sign of just how much fear stalks global financial markets. It's not so much that investors love U.S. Treasurys but that they hate almost everything else. The money pouring into Treasurys is money that's not going into loans or capital investments that expand the global economy. Money is cheap if you look only at Treasury yields, but it's not readily available to all the creditworthy borrowers who need it. Just ask a prospective homebuyer in the U.S. who has been turned down for a mortgage. Or ask small-business owners in Japan or China who can't get financing at anything less than ruinous rates -- if they can get financing at all.
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Second, the rally is a sign of just how unmoored the global financial system has become from past standards -- and how much work needs to be done to create a new system. It's one thing to laugh at Standard & Poor's ratings; it's something else entirely to come up with a new system that accurately reflects credit risk and creditworthiness. Without some system to create confidence among buyers and sellers, whole swaths of modern finance -- the derivatives market comes to mind -- become, at the least, less efficient and, at worst, frozen with indecision.
Standard & Poor's decision to downgrade, the credit rating of the United States -- and the way that the company handled that decision -- has shown how badly the current system is broken.
S&P's bad decisionWhen Standard & Poor's announced the downgrade, it got caught in a $2 trillion math error. Standard & Poor's initially overestimated the size of future U.S. deficits by $2 trillion, an error that Treasury officials rushed to publicize. Standard & Poor's admitted the error and lowered its projection for the ratio of government debt to gross domestic product for 2015 by 2 percentage points. In its initial downgrade the company had said that the ratio of U.S. debt to GDP would be 77% in 2015 and hit 78% in 2021. In truth, a shift from 77% to 75% doesn't seem significant if you buy into Standard & Poor's framework for making it decision.
But instead of leaving the defense of its decision there, the company then managed to call into question its entire rationale for its downgrade. The $2 trillion math error wasn't significant, Standard & Poor's said, because it had based its decision on its judgment of U.S. politics.
At that point, Congress had finally passed a package that combined an increase in the debt ceiling with $2.4 trillion in spending cuts over 10 years. But Standard & Poor's had calculated that it would take a $4 trillion package of cuts to demonstrate the U.S. government's commitment to long-term deficit reduction.
Realizing, I guess, that you can't argue that a $2 trillion math error is insignificant but a $2 trillion shortfall in the deficit reduction package is significant, Standard & Poor's said its downgrade was based not on the result of the battle in Congress but on what the company called the "extremely difficult" political discussions. The "debate this year has highlighted a degree of uncertainty over the political policymaking process which we think is incompatible with the AAA rating," Standard & Poor's analyst David Beers said in a conference call after the downgrade.
To me, that kind of thinking makes it look like Standard & Poor's is making it up as it goes along. The trends in the U.S. deficit numbers have been clear for a decade or more. The demographic facts of life that have been driving the explosion in medical and retirement costs aren't new. And while U.S. politics are nastier than ever, they don't represent some sudden turn from fiscal responsibility to fiscal recklessness.
Congress is suddenly unwilling to deal honestly with the U.S. deficit? Come on, Standard & Poor's.
Several critics of the downgrade decision have questioned Standard & Poor's sudden assertion of political expertise. They've certainly got a point. What expertise does this company have in political analysis?
To me, it's the shift in criteria that's more disturbing than the issue of credentials in political analysis for Standard & Poor's. If we're suddenly going to rate debt based on politics, won't we be looking at downgrades across the debt landscape? And if today's credit ratings expand to political analysis, what might they expand to include tomorrow?
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Mail"},"omniAccount":"MSNPORTALSCP","ratingsControlId":"ratCntrlBinary","ratingsItemId":"scp:bbcdiscussion:e1427367-1e1f-47dc-bfcb-ad2b1a0f3083","appUri":"http://social.msn.com/boards","pageUrl":"http://money.msn.com/investing/why-markets-are-coming-undone-jubak.aspx","ratingTags":["00120065-0000-0000-0000-000000000000","00000065-02a6-0000-0000-000000000000","ART"],"fblkShow":true,"fblkAppId":"","fblkRef":"","fblkTrkName":"","fblkTrkVal":"","twtShow":true,"twtTrkName":"","twtTrkVal":""}); }); /**/ 16CommentsNewestOldestBestWorstControversialIconoclast1011 hour agoIt's high time the 3, principal rating agencies were carefully scrutinized by, at a minimum, the SEC. Many have questioned, rightly, who gave the agencies the 'right' to rate. The recent S&P incident, downgrading the US sovereign debt, is disgraceful, not that the US is in good financial shape, but to inject politics into the evaluation process is just plain outrageous. And dodging the math error was quite simply dishonest. In coming up with their rating, S&P's managers might just as well use a crystal ball. We were led to believe ratings were based on financial criteria by so-called experts in micro- and macro-economics. Before you know it, the ratings are liable to be based on weather forecasting, and we all know how accurate that is. Stop posting these kinds of comments. Write your congressional representatives and tell them to look into the activities of the rating agencies with the objective of curbing their unjustified influence. Freedom of the press and the right to express an opinion are not questioned, but as we all know, you're not entitled to yell "fire" in a crowded theater, especially when there's no fire. 0 0ReportSpamchucky125 hours agoActually I think S&P went too easy on the downgraded score...in reality our credit deserves less than AA. We need to start paying back our debts!...PERIOD!. What kind of example is the government setting for this leech infected country?...It's bad enough that we have a bunch of scumbag lazy losers who want to keep receiving hand-outs from the hard working citizens, but now the Government is setting an example of, Hey!...Let's not pay our bills!...GUESS WHAT? What happens when us hard working folks carring all the welfare scum decide we've had it?...What if we don't pay any of our bills?...There's a great idea!...The Government doesn't pay their bills, so why should I?
PS... Obama is a fricking moron! ...He is deliberately trying to ruin this country and turn it into a socialist country!...The sooner we get this POS out of office the better!
4 6ReportSpamDoug (Out in the cold) 5 hours agoS & P's down grade was not a surprise, they said they were going to do it. I am just not sure if the credit rating agencies fully appreciate what a stampede looks like when you got elephants, donkeys, bears and bulls running over everything in sight. 2 0ReportSpamelectric car fan5 hours agoi dont think there can ever be economic recovery with the current rules on speculators allowing a 40% traders tax on gas in fact thats a gaurentee for no recovery when the entire country has to pay 40% OVER THE ACTUAL SUPPLY DEMAND FUNDEMENTALSW 0 0ReportSpamP.O. Carl6 hours agoSteven44: Took a look at "land of sheep". One comment there said that the global economy will recover because it simply has to. This may be so, but Japan has been in the same rut that we are in for 17 years. I believe that all economies are having difficulty adjusting to the new level of lower consumption. 2 0ReportSpamP.O. Carl6 hours agoJim, wasn't the S&P and other rating agencies being paid by the Wall Street investment banks to rate the mortgage backed securities that they were selling? What a racket Wall Street has. They cannot lose, their bank the FED will bail them out every time and they know it. 4 0ReportSpamSteven446 hours agoThe whole S&P rating system is a joke. AAA one day then AA the next? It's not a 5th grade report card is it? It's pretty arbitrary and whimsical. Not much happens from one day to the next but an upgrade or downgrade makes big headlines. It's silly. The US will pay back the debt somehow because now they actually realize it's a big problem. It won't be easy but they will be back up to the arbitrary AAA very soon. As I mentioned earlier, Google "land of sheep" for a much clearer look at what's going on internationally in terms of investing. 5 0ReportSpamSomeone6 hours ago Tell them they need to pay down their card until they have more room to spend. NOT increase their credit line and tell them to have at it. So we increased our spending line and said yea, yea, yea we'll pay it back.My boyfriend thinks the same with me. He is eight years older than me, lol. We met online at A'gelessC'upid.C óM a nice and free place for younger women and older men, or older women and younger men, to interact with each other. Maybe you wanna check it out or tell your friends. 2 7ReportSpamSteven446 hours agoGoogle "land of sheep" for an interesting financial blog that gives real advice and thoughtful international investing ideas. The S&P is not only bad at rating the credibility of countries. They don't know how to rate ANYTHING. They really are making it up as they go along. Literally 3 business days ago they downgraded Google from a "buy" to a "sell". Today they upgraded it and no new news came in about the company over the past couple days. It's ludicrous! The way an investor can take advantage of this is understanding that the S&P ratings do move markets in the short term. Upgrades and downgrades are still major headlines. Go against them with a stop loss and you'll make more money than you'll lose after watching them change their arbitrary ratings around. 2 2ReportSpamDark Times6 hours agoLOL... Now I do agree with that. 1 1ReportSpamlol lol lol lol6 hours agoActual S&P got it wrong - they should have gave an A rating (not AA+).
7 2ReportSpamjustoneguy7 hours agoYa gotta break eggs to make an omelet. The market? Worry worts, Debbie Downers, 'Slick' home office Day Traders and Gloomy Gus' need to get OUT of the kitchen and that's what's happening now. Time to grab some up for the long haul. THAT is what the market is about. 2 2ReportSpamHOF137 hours agoPersonally, I find this to be a very interesting article. The notion that S&P got it wrong isn't nearly as unsettling to me as is the fact that the REASON they got it wrong was they didn't really pay very close attention over the last 10 years. The 'downgrade' seemed rather silly when it happened, and this article only supports that line of thought. It brings to mind the words of the great philosopher Bertrand Russell, who famously said, "Consistency is the hobgoblin of little minds." However, consistency is exactly what we, and this market, need right now.
As an aside, I didn't see any "touting" of Treasury Bonds by Mr. Jubak, nor any suggestion that they are a viable place for your investment dollars right now. Matter of fact, I didn't see any investment suggestions at all.
Disclosure: I have no individual treasuries, but several bond funds and ETFs.
8 0ReportSpamDark Times7 hours agoWhy would he call it a "bungled downgrade"? If anyone really thinks that the US did not deserve the downgrade needs to reconsider. If your teenage child is spending money on their credit card and maxs it out, what would any right minded parent do? Tell them they need to pay down their card until they have more room to spend. NOT increase their credit line and tell them to have at it. So we increased our spending line and said yea, yea, yea we'll pay it back.
Sure we will.
14 2ReportSpambuzzybucks7 hours agoUsually Jubak's articles at least plausible, not so here. Do not go out and buy bonds on the basis of what is written in this piece of tripe. I noticed that there was no usual disclaimer, something to the effect of "Mr. Jubak is heavily invested in treasury bonds".
Bonds will cause you to loose purchasing power. Why would Jubak tout them??????
2 9ReportSpamFinal Word8 hours agoThe downward stock rally has little to do with the economy, with the exception of using the opportunity to get the ball rolling to cash in on fear and worry over the nation’s debt. The wheeler-dealers have captured the bucks of those who cashed out after the steep market drops, thus played on fears, which is why I keep on saying to hang on to your investments and let them fall short instead.
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