Sunday, August 14, 2011

S&P—The New Villain Of Obama Administration

Senate is upset with Standard & Poor (S&P) and they want to investigate them for downgrading US’s rating one notch from the coveted AAA grade. Senate Banking Committee Chairman Tim Johnson lashed out, “As the financial markets stumble, investors continue to regard Treasury debt as a safe haven in times of economic uncertainty. This irresponsible move by S&P may, however, have spillover effects that tax the American people by increasing interest rates on home loans, credit cards, and car loans, and by increasing the cost of finance for some state and local governments. I am deeply disappointed in S&P’s decision to enter into the game of political punditry.”

Not to be undermined by this, the Treasury Secretary Timothy Geithner shot out, “They've shown a stunning lack of knowledge about basic U.S. fiscal budget math. And I think they drew exactly the wrong conclusion from this budget agreement.”

Those are strong words.

S&P is the new villain in the financial world for downgrading the credit rating of USA. It is the same rating agency that had consistently given the failed Lehman Brothers and other financial institutions top rating when they did not deserve that. Was S&P bad then, or, are they bad now?

What is a triple-A rating by the way and what does it mean?
In the rating business there are two major houses, S&P and Moody’s, who are market mover and both have been caught napping during the past major financial turmoil. This time however, S&P appears to be wising up and inclined to mend their reputation. On April 18, 2011,S&P had warned that a debt ceiling increase without meaningful budget reforms would still merit a downgrade. The long term US fiscal imbalance is nothing new and it had been in the making for at least two decades now. S&P had correctly pointed out that if the politicians do not wake up now and refrain from silly game playing, a future default becomes a significant.

Moody’s is still playing the catch up game. On July 13, they placed the US credit rating on watch for possible downgrade and also declared that if US government did not take significant deficit reduction measures with a debt ceiling increase they would assign a negative outlook. On June 8, 2011, a third rating agency Fitch threatened to place the US on negative watch if the ceiling was not raised by August 2nd.

The triple-A rating signifies that the government is stable and bonds it issues are considered safe, thereby, the nation can borrow funds at the lowest possible cost. By downgrading the US from AAA to AA+, S&P is not saying that the US govt. is likely to default, it is saying that likelihood of a default or a loss of principal/interest has increased. There are 18 different grades and a transition from the highest rating to the second highest rating does not signify a massive risk change. The downgrade for the US implies that the credit risk of the US has gone from minimum to very low.

If S&P had kept the US rating unchanged and the country would default that would totally discredit the agency, and now they know, that with Europe declaring to come up with their own rating agencies it would be a disaster for them if they fail to do their watchdog duty one more time. The CIA World Fact book mentioned that in 2010, the debt to GDP ratio for the US was 59% in comparison with 34% in Canada and 22% in Australia. Obviously, it does not seem we are in the same league as either of them.

First published on Technorati

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