S&P Downgrades US Credit Rating from AAA to AA-plus, Impacting the Dollar

Dollar to drop on S&P move; safe-haven demand seen

By Saikat Chatterjee

Sun Aug 7, 2011 5:17am EDT

HONG KONG (Reuters) -

The U.S. dollar may weaken and Treasury yields rise when Asian markets reopen on Monday, though any selling in response to ratings agency S&P's downgrade of the United States is likely to be tempered by the escalating crisis in the euro zone.

The S&P cut in the U.S. long-term credit rating by a notch to AA-plus is an unprecedented blow and results from concerns about the nation's budget deficits and climbing debt burden. It called the outlook "negative," signaling another downgrade is possible in the next 12 to 18 months.

"The initial reaction will be a high degree of uncertainty and thus volatility since investors will not know where to turn for safety," said Mark Mobius, executive chairman of Templeton Emerging Markets group, in an email to Reuters.

"During the sub-prime crisis safety was in U.S. Dollars and U.S. Treasuries. Now that anchor to the global community is deteriorating," added Mobius, whose unit oversees $50 billion in emerging market assets.

Fears of a slide back into recession for the world's biggest economy prompted a global sell-off that wiped $2.5 trillion off company values over the past week, with consumer discretionary shares of firms dependent on external demand likely to be singled out for more punishment.

The fall in global share prices, as measured by the MSCI All-country World Index, was the biggest weekly decline since early October 2008, according to Thomson Reuters Datastream.

Market players warned the U.S. downgrade was likely to exacerbate a sharp contraction in risk appetite, and could see investors shift to the low-yielding Japanese yen and the Swiss Franc, despite market interventions from their respective authorities to weaken the currencies last week.

But they said fears that Europe's debt crisis could engulf core economies Spain and Italy, where sovereign debt yields have soared to 14-year highs, meant investors may still seek a safe-haven in the dollar, despite the U.S. woes.

Goldman Sachs strategists said there was a one-in-three probability of a U.S. recession due to the worsening European crisis, the possible failure to extend payroll tax cuts and elevated levels of joblessness, despite a slight dip in the U.S. unemployment rate in July.

"Simply put, market sentiment appears acutely vulnerable given the build-up of concern on a sharper U.S. slowdown and speculation on the appropriate policy response and lingering fears stemming from the sovereign debt crisis in Europe," Citigroup strategists said in a note.

The benchmark MSCI all-country world stocks index fell to its lowest level since September 2010 last week, and has slumped more than 12 percent since late July.

The benchmark MSCI index of Asia Pacific ex-Japan stocks fell 8.7 percent last week.

Meanwhile, global leaders scrambled to discuss the U.S. sovereign rating downgrade and Europe's debt woes, and may issue a statement after a conference call, a Japanese government source said on Sunday.

Yields on benchmark U.S. ten-year treasury notes rebounded smartly to 2.56 percent on Friday but were not far away from a record low of near two percent hit during the throes of the global financial crisis.

In a sign of how nervous investors have become, data from Lipper showed investors pulled nearly $66 billion from money market funds in the week ended August 3, the second-largest weekly net outflow on record. The record outflow was seen during the week ended September 17, 2008.

(This story corrects the reference to payroll tax cuts in paragraph 9)

White House adviser slams S&P after U.S. downgrade

WASHINGTON | Sat Aug 6, 2011 9:45pm EDT

WASHINGTON (Reuters) -

A top White House economic adviser slammed Standard & Poor's on Saturday for having stuck with its decision to downgrade the U.S. credit rating despite having made a $2 trillion mistake in its fiscal projections.

"The magnitude of their error combined with their willingness to simply change on the spot their lead rationale in the press release once the error was pointed out was breathtaking," National Economic Council head Gene Sperling said in a statement.

"It smacked of an institution starting with a conclusion and shaping any arguments to fit it," he said.

S&P, a major credit rating agency, cut the long-term U.S. credit rating by one notch from AAA to AA-plus on Friday on concerns about the government's budget and rising debt burden.

The U.S. Treasury said the rating agency's debt calculations were wrong by some $2 trillion. S&P has confirmed it changed its economic assumptions after discussion with the Treasury Department but said that did not affect its decision to downgrade.

A major theme in S&P's analysis was the apparent breakdown in the ability of Republicans and President Barack Obama's Democrats to govern effectively, as evidenced in the fractious negotiations leading to a last-minute debt limit deal that brought the United States to the edge of default.

(Reporting by Laura MacInnis; Editing by Eric Walsh)

G7 finance leaders agree to talk on Monday: report

TOKYO | Sun Aug 7, 2011 6:17am EDT

TOKYO (Reuters) -

The Group of Seven leading economies agreed to hold an emergency phone meeting of finance ministers and central bank governors on Monday, Kyodo news agency reported on Sunday.

At the meeting, Finance Minister Yoshihiko Noda is expected to pledge that Japan will continue to buy U.S. Treasuries, Kyodo said without citing any sources.

The ministers will likely discuss measures to prevent turmoil in financial markets amid U.S. and European debt problems, it said.

Japanese government sources have said the G7 finance leaders will likely hold an emergency phone meeting, probably before Asian markets open on Monday, to discuss the twin debt crises in Europe and the United States, and may issue a statement after the meeting.

(Reporting by Leika Kihara, Editing by Jonathan Thatcher)

Wall St. downplays downgrade. Will markets listen?

Reuters, Aug 6, 2011 18:49 EDT

Reporting for this post was done by the U.S. markets team in New York.

A number of Wall Street analysts have reacted to the historic downgrade of the U.S. AAA rating on Friday evening with a shrug. Some argue the ratings firm’s warnings about the U.S. debt deal offered an early signal, while others dismissed the action, questioning the company’s record of giving AAA ratings to housing assets that turned out to be toxic.

Vassili Serbriakov, currency strategist at Wells Fargo in New York, said:

It’s not entirely unexpected. I believe it has already been partly priced into the dollar. We expect some further pressure on the U.S. dollar, but a sharp sell-off is in our view unlikely.

Paul Dales, chief U.S. economist at Capital Economics in Toronto:

I don’t think it will mean too much to be honest. There will probably be an initial market wobble — FX markets might struggle and Treasury yields might fall a bit. The bigger picture is really that the world is not much different.

Greg Salvaggio at Tempus Consulting in Washington was more scathing.

I really find it quite amazing that a credit agency that could rate mortgage backed securities AAA has decided to downgrade the U.S. government.

Still, following the worst week for stocks since the financial crisis and with concern still high about Europe’s own debt woes, it is not difficult to envision a turbulent week ahead.

Importantly, investors are bracing for a series of downgrades of other entities like fallen mortgage giants Fannie Mae and Freddie Mac, whose credit strength is directly linked to the U.S. government’s, and certain municipal bonds that are backed by Treasuries.

William Larkin, fixed-income portfolio manager at Cabot Money Management, in Salem, Massachusetts, describes the risks in more detail:

I think we are going to test the system on Monday. One of the problems that everyone is worried about with a downgrade is there is a lot of investment guidelines where you are forced to maintain certain credit quality, and if you are bumping up against it, all of a sudden you are going to fall below your guidelines, so that means you probably have to buy more Treasuries and probably sell corporate debt or something like that. The interesting thing is going to be the impact on the municipal bond market because a lot of municipal bonds have as collateral U.S. Treasury securities. It is a tiny market and it is easily spooked but it is heavily invested in by retail investors. That is going to be the one I am going to be keeping an eye on.

Given that level of uncertainty, it’s hard to see markets reacting with anything but trepidation as they get used to a new world, one where the safety anchor of AAA U.S. Treasuries is no longer the golden benchmark. Curiously, the U.S. bond market might actually rally as riskier assets selloff, pushing already very low bond yields even lower. But this is a privilege the United States could be on its way to losing, particularly if other rating agencies follow S&P’s lead.

Why the S&P downgrade was delayed

Reuters, Aug 5, 2011 19:56 EDT

The S&P downgrade noise out of Washington right now is decidedly unclear; most of it seems to be confined to Twitter, with this being one of the few exceptions. But the general understanding is that S&P decided to downgrade the US, told the White House, got serious pushback, and ultimately — for the time being — did nothing.

There are three points worth making here, even in ignorance of the details of what went on behind the scenes today.

Firstly, talk of debt-to-GDP ratios and the like is a distraction. You can gussy up your downgrade rationale with as many numbers as you like, but at heart it’s a political decision, not an econometric one.

Secondly, the US does not deserve a triple-A rating, and the reason has nothing whatsoever to do with its debt ratios. America’s ability to pay is neither here nor there: the problem is its willingness to pay. And there’s a serious constituency of powerful people in Congress who are perfectly willing and even eager to drive the US into default. The Tea Party is fully cognizant that it has been given a bazooka, and it’s just itching to pull the trigger. There’s no good reason to believe that won’t happen at some point.

Finally, it’s impossible to view any S&P downgrade without at the same time considering the highly fraught and complex relationship between the US government and the ratings agencies. The ratings agencies are reliant on the US government in many ways, and would be ill-advised to needlessly annoy the powers that be. On the other hand, the government has been criticizing them harshly for failing to downgrade mortgage-backed securities even when they could see that there were serious credit concerns. So by that measure they have to downgrade the US: the default concerns we saw during the debt-ceiling debate were real and can’t be ignored.

I wouldn’t be at all surprised to learn that substantially all of today’s market action was attributable to the status of the S&P downgrade. Stocks opened higher on the strength of a decent jobs report, fell off when it looked as though the downgrade was coming, and then rallied back when it became clear that it wasn’t, ultimately ending the day flat.

If that’s the case, then we can probably expect an immediate sell-off of no more than a few hundred points on the Dow if and when the S&P downgrade finally arrives.

But that won’t be the end of the story, by any means. Alan Taylor and Christopher Meissner have a long new paper out looking at the value of America’s “exorbitant privilege” — they put it at roughly 1% of GDP and falling. That’s $150 billion a year or so. An S&P downgrade would surely accelerate the decline, by some unknown amount.

Do the mandarins at S&P — people who, it seems, can’t even get basic macro sums right — really want to cost the US economy tens of billions of dollars a year by downgrading the country’s debt and causing all manner of potential market mischief as a result? I can’t see that there’s much in it for them, even if a downgrade is the intellectually honest thing to do.

Eventually, we can be sure that the US will be downgraded. But this is a bit like the banks’ rearguard action on debit interchange: simply delaying the inevitable is worth billions to the government. So expect as many delaying tactics as Treasury can lay its hands on. You can be sure that everybody in the sovereign group at S&P is under enormous pressure right now. They’re going to take their time before taking this essentially irrevocable step.

Update: This was, obviously, posted about half an hour too early: S&P went ahead and downgraded the US after all. It’s not a surprising move, but it’s seismic all the same. The immediate consequences will be significant; the long-term consequences will be orders of magnitude larger. And I do think it’s fair to pin the lion’s share of the blame on the existence of the debt ceiling.

Et tu, S&P

Reuters, Aug 5, 2011 22:13 EDT

By Matthew Goldstein

A few weeks ago S&P telegraphed that it would soon strip the U.S. of its vaunted Triple A rating and downgrade the government’s debt by a slight notch to AA+. And Friday night, the major credit rating did just as it telegraphed.

For the moment, let’s not debate whether S&P is engaging in politics, or should even be in the business of rating the debt of countries. The latter issue, however, is something that our nation’s political leaders and regulators may want to consider at some point.

But for right now, it’s worth noting that over the past decade or so, S&P has moved on downgrading corporate debt and esoteric securities as if it was still operating in the days of the telegraph.

Remember, Enron and Worldcom.

And who can forget the big role credit rating agencies like S&P played in allowing Wall Street banks to market subprime-backed CDOs as Triple A securities. In many ways, the rating agencies were Wall Street’s enablers and bought into the fiction that securities built from crappy mortgages would continue to payout because a national crash in housing prices was something unthinkable. Or, at least, something the rating agencies never seemed to consider throwing into their magic default models.

Additionally, S&P was the only major credit rating agency to slap a rating–an A rating–on ACA Capital. Don’t remember ACA Capital? Well before AIG took the lead in insuring flawed CDOs and other mortgage-backed securities, ACA Capital was Wall Street’s go to shop for guaranteeing exotic securities. ACA could only do this because of the A rating it had from S&P.

In the early days of the financial crisis, ACA Capital went bust. It’s collapse caused some write-downs for Wall Street banks and was a harbinger of things to come for AIG, but it was quickly forgotten. That is until last year, when the Securities and Exchange Commission sued Goldman Sachs over the now notorious Abacus CDO deal. And lo and behold, the tiny insurer was right there in the mix having guaranteed a portion of the deal and helped select some of the iffy mortgage-backed securities for the CDO.

Something to think about as you mull S&P’s actions with regard to U.S. Treasuries.

Update: As a reader points out below, the end for ACA Capital came when S&P downgraded it. But as you’ll see from a story I did in November 2007 for old BusinessWeek, even S&P was late in the game on that downgrade. Full disclosure: In 2007 BusinessWeek was still owned by McGraw Hill, the parent of S&P.

What happens when citizens lose faith in government?

Reuters, Aug 5, 2011 10:32 EDT

By Chrystia Freeland

Tolstoy thought unhappy families were unique in their unhappiness.

But when it comes to countries, these days the world’s gloomy ones have a lot in common. From Fukushima to Athens, and from Washington to Wenzhou, China, the collective refrain is that government doesn’t work.

“2011 will be the year of distrust in government,” said Richard Edelman, president and chief executive of Edelman, the world’s largest independent public relations firm.

For the past decade, Mr. Edelman has conducted a global survey of which institutions we have confidence in and which ones are in the doghouse. In 2010, the villains were in the private sector — from BP, to Toyota, to Goldman Sachs, corporations and their executives were the ones behaving badly.

But this year, Mr. Edelman said, we are losing faith in the state: “From the sovereign debt crisis in Europe, to the government’s response to the earthquake in Japan, from the high-speed rail crash in China, to the debt ceiling fight in Washington, people around the world are losing faith in their governments.”

Even the Arab Spring, Mr. Edelman mused, was an extreme expression of the same breakdown in the people’s support for those who rule them.

After that, though, the global parallels start to break down. In our kitchens, on Facebook, and in our public squares, a lot of us, in a lot of places, are talking about how we long to kick the bastards out. But how we act on that angry impulse varies widely. Figuring out when and how our private anger translates into public action, and of what kind, is one of the big questions in the world today.

One answer comes from Ivan Krastev, a Bulgarian political scientist. One of Mr. Krastev’s special interests is in the resilience of authoritarian regimes in the 21st century. To understand why they endure, Mr. Krastev has turned to the thinking of the economist Albert O. Hirschman, who was born in Berlin in 1915 and eventually became one of America’s seminal thinkers.

In 1970, while at Harvard, Mr. Hirschman wrote an influential meditation on how people respond to the decline of firms, organizations and states. He concluded that there are two options: exit — stop shopping at the store, quit your job, leave your country; and voice — speak to the manager, complain to your boss, or join the political opposition.

For Mr. Krastev, this idea — the trade-off between exit and voice — is the key to understanding what he describes as the “perverse” stability of Vladimir V. Putin’s Russia. For all the prime minister’s bare-chested public displays of machismo, his version of authoritarianism, in Mr. Krastev’s view, is “vegetarian.”

“It is fair to say that most Russians today are freer than in any other period of their history,” he wrote in an essay published this spring. But Mr. Krastev argues that it is precisely this “user-friendly” character of Mr. Putin’s authoritarianism that makes Russia stable. That is because Russia’s relatively porous dictatorship effectively encourages those people who dislike the regime most, and have the most capacity to resist it, to leave the country. They choose exit rather than voice, and the result is the death of political opposition: “Leaving the country in which they live is easier than reforming it.”

Nowadays, the Chinese find little to emulate in Russia. That includes flavors of authoritarianism: Theirs is the more carnivorous variety, including locking up dissidents, rather than encouraging them to leave, and censoring the Internet, rather than allowing the intelligentsia to be free but ignored.

Mr. Krastev’s thinking suggests a perverse possibility — that Mr. Putin’s slacker authoritarianism, while less able to deliver effective governance than the stricter Chinese version, may actually prove to be more enduring. The recent outburst of public rage in China over the high-speed rail crash is one piece of supporting evidence.

Mr. Hirschman came up with his theory of exit and voice in the United States, and he believed that exit had been accorded “an extraordinarily privileged position in the American political tradition.” That was partly because the United States was populated by exiters and their descendants — immigrants who chose to leave home rather than reform it — and partly because for much of American history the frontier made it possible to choose exit without even leaving the country.

For Americans, that sort of internal exit is no longer an option. Whatever you may think of the political agenda of the Tea Party, or of its wealthy supporters and media facilitators, it is at heart an ardent grass-roots movement whose angry and engaged participants have chosen voice over exit or apathy.

But when you look at what they are using that voice to advocate, you may decide that Mr. Hirschman was right after all about the American national romance with exit. The Tea Party’s engaged citizens aren’t so much trying to reform government as to get rid of it — the only possible version of exit when the frontier is gone and you already live in the best country on earth.

There is something, as Mr. Hirschman understood, particularly American about that impulse. But it may also be rooted in a theory about how to reform government that has been popular on both sides of the Atlantic in recent decades. That is the idea that creating competing, private-sector-operated alternatives to the public sector is a good way to force the state to raise its game. The charter school movement in the United States is one example. Prime Minister David Cameron’s advocacy of the Big Society is another.

Looked at through Mr. Hirschman’s lens, however, these private providers of formerly state services may have quite a different effect. If they allow the best and the most disgruntled citizens to exit the state, they might make the state-supplied option worse, rather than better. As Mr. Hirschman argued: “This may be the reason public enterprise … has strangely been at its weakest in sectors such as transportation and education where it is subjected to competition: The presence of a ready and satisfactory substitute for the services public enterprise offers merely deprives it of a precious feedback mechanism that operates at its best when the customers are securely locked in.”

The 21st century is the era of mass travel, open borders, instant communication and the affluent citizen-consumer. Russian oligarchs aren’t the only ones who can exit — a lot of us can. It is no wonder so many of us distrust our governments. But in this age of exit, do we have much chance of reforming them?

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