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The historic US downgrade: questions and answers

Some of the immediate impacts of Standard & Poor's historic downgrade of the US credit rating are becoming known. But looking further ahead, many questions remain.

The historic US downgrade: questions and answers

Since Friday we've seen an intensification of the stock market crash, a weaker dollar and falling US treasury yields as investors take stock of the decision from Standard & Poor’s to downgrade the United States’ AAA credit rating.

The impact of the downgrade to AA+ is gradually becoming clearer. Yet visibility remains severely impaired.

We do know the downgrade is more symbolic than anything else…

This is not a default and from that perspective, economists point out the one notch downgrade is close to being irrelevant.

The timing was bad, coming as it did at the end of the worst week for equities since the 2008 crisis, with sentiment on a knife-edge and investors panicking.

It’s also more about politics than economics, much to the anger of several major investors who view S&P’s decision as a reflection of the political judgement of one institution. In its statement on Friday, S&P said: ‘The political brinksmanship of recent months highlights what we see as America's governance and  policymaking becoming less stable, less effective, and less predictable than what we previously believed.’ The Senate banking committee is now reportedly scrutinising the decision.

Warren Buffett told CNBC on Monday that, ‘Our currency is not AAA, and in recent months the performance of our government has not been AAA, but our debt is AAA.’

That said, the simple fact is that US politicians have failed to bring their debt under control.

…but we don’t know if more will follow

The knock-on effects of the downgrade are already being seen, with institutions reliant on US guarantees facing predictable downgrades, including Israeli sovereign bonds and the debt of Fannie Mae and Freddie Mac, the mortgage finance giants.

Of the other two major rating's agency, Moody's has reiterated its warning that the US will be stripped of its prized AAA-rating by 2013 if its fiscal or economic outlook deteriorate further. Fitch Ratings has said that it expects to finish its review of US sovereign credit ratings by the end of August.

As Paul Atkinson of Aberdeen Asset Management points out, history shows that subsequent upgrades for dethroned AAA rated nations take between eight and 18 years and ‘follow a long period of fiscal retrenchment, backed by political will’.

A bigger continued focus will be the state of the US economy…

Whatever ratings actions are taken, the US is not going to default and markets will draw their own conclusions independent of S&P.

Recent weak economic data, and what that tells us about the poor strength of the US economic recovery has been a bigger driver of market falls in the past week, as has the eurozone debt crisis. These are real issues needing real measures from governments. The downgrade – which did not come as a surprise to markets – adds to the instability fostered by the debt problems.

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5 comments so far. Why not have your say?

Kirsteen Mackenzie

Aug 09, 2011 at 16:03

Amazing....these are the guys who completely failed to see/understand the Banking crisis and the property bubble ......Junk bonds etc before that. Moody's in the same boat.

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Aug 09, 2011 at 19:27

The writing has been on the wall for many years.

There have been many commentators remarking on this fact, but the politicians, to appease those don't vote for them had ignored prudent decisions and stuck by their dogmas.

In this respect I will give credit to Obama, definitely a smooth talker, and the greater part of the blame lies with the Republicans, for their blind intransigence in respect of the crisis that face them. Alone Are Not Sufficient. There Has To Be a Two-Pronged approach, something they appear to be incapable of understanding.

It is easy to blame the Obama administration for dealing with a problem that has long been outstanding, care for those that have done their bit for the nation and now need to benefit from the results of their labours.

If America wants to remain at the forefront, they should lead the way by addressing their excesses which have resulted in the current debt mountain.

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Chris Clark

Aug 10, 2011 at 07:55

These guys didn't fail to see the banking crisis. They switched off their radar so they couldn't see it. Around 2003, they adjusted their sub-prime mortgage calculations that were showing signs of stress at the behest of banks, because each CDO mortgage fund containing around 2,000 sub-prime mortgages and given a triple A rating could earn the Credit Rating Agency about $200,000 for a few hours work.

But if you were to give the fund anything less than Triple A, then the bank would stop sending the work to you and go to one of your 2 competitors. Changing the mortgage formula to suit the rating and avoid red flags became the norm.

As for conflict of interest, well, it looks more like that was designed in from the outset rather than any failing of principles or procedures.

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joe stalin

Aug 10, 2011 at 09:36

It is probably not far from fraud. It has already been noticed that investment banks colluded with hedgefunds and rating agencies in the MBS market. It just beggar belief why a criminal case has yet to be launched. If the regulators do wish to get to grips with this then the case which has been filed against BoAML by AIG for $10bn deserves to succeed and hopefully others will follow and take on the likes of Goldman Sachs.

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mo khan

Aug 14, 2011 at 16:25

Has Standard & Poor’s downgraded it self too?

How can we tell!

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