4 Things to Remember About the Credit Downgrade (The Motley Fool)

Five days, a stock market plunge, and a flurry of finger-pointing later, we're still trying to figure out what Standard & Poor's downgrade of U.S. Treasuries really means. Here are four points I'd keep in mind.

1. It had no impact on Treasuries.
The biggest risk of a Treasury downgrade was the possibility that interest rates would rise. That could add trillions to future federal borrowing costs and stifle economic growth.

But interest rates didn't rise at all after the downgrade. In fact, they've plunged. Monday turned out to be the eighth best day for 10-year Treasuries in modern history. The biggest irony of downgrading Treasuries is that it instantly increased global demand for ... Treasuries. One blogger, mocking the stereotypical investor, quipped: "Treasuries were downgraded? Wow! Sell my entire stock portfolio and get me into Treasuries!"

How do you explain that? It's simple. The risk that led to the downgrade was political. But financially, Treasuries are still the safest, most liquid assets in the world. And the U.S. still has the means to pay its bills. That isn't a question. Investors still flock to Treasuries whenever there's a panic. It's where they feel safe. Incredibly, the Treasury can borrow money for 10 years today at less than half the interest rate offered a decade ago, when the government ran surpluses.

2. It will have no impact on banks.
Banks are required to hold minimum levels of buffer (capital) against certain assets. Risky assets require big buffers, less risky assets require smaller buffers, and Treasuries require basically no buffer at all, since they're considered risk-free.

That could have changed after the downgrade. Without a pristine credit rating, the rules regarding how much capital banks have to hold against Treasuries could have been rewritten, forcing them to scramble to raise more capital. This could have been gut-wrenching, since Bank of America (NYSE: BAC - News), Wells Fargo (NYSE: WFC - News), Citigroup (NYSE: C - News), Goldman Sachs (NYSE: GS - News), and JPMorgan Chase (NYSE: JPM - News) collectively own almost $1 trillion worth of government securities.

But within minutes of the downgrade, the Federal Reserve issued a statement making it clear: The downgrade will not change how much capital banks are required to hold against Treasuries. This was an incredibly important development that went largely unnoticed. Anything different could have sparked a banking panic. Be thankful for it.

3. The rating agencies' credibility is dubious.
S&P downgraded the nation's credit due to political bickering. That political bickering is mostly about the massive accumulation of debt in recent years. And why has debt exploded in recent years? Because of the financial crisis. And who caused the financial crisis? If you had to come up with five broad culprits, the rating agencies would be one of them. We could not have had a housing bubble like we had without the rating agencies. And we wouldn't have today's deficits without a housing bubble.

Think of it that way, and S&P effectively downgraded itself.

Now, mentioning S&P's housing-bubble fumbles when criticizing the recent downgrade is misleading. While they work under the same roof, the analysts who rate housing bonds are not the same analysts who rate sovereign debt.

But there's another valid criticism beyond S&P's past performance. As I wrote on Monday, S&P's original downgrade report had a glaring math error. When that error was corrected, the nation should have, by S&P's original standards, been in the clear for a stable credit rating. Instead, the revised report changed the benchmarks so that forecasted deficits still fell into a danger zone.

The snafu underscores an important point: S&P's downgrade is the opinion of one very fallible group of people. It's outrageous to think that it should shift the path of the global economy.

4. If there's anyone to blame, it's us.
S&P made it clear: the credit downgrade was mostly a demotion of our political system. Our deficits are large, but our political infighting is massive.

Motley Fool co-founder David Gardner asked an important question yesterday. Paraphrasing a famous Warren Buffett quote, he asked: "Would you be willing to put every last dollar you have into the hands of this particular public official to manage on behalf of our future?"

David didn't mean it literally. But "we stand a far greater chance of improving, rather than further undermining, our creditworthiness as a nation if we as its citizens begin to ask this Buffett question of ourselves prior to casting votes," he wrote.

I think you can take it a step further. A recent poll shows that just 14% of Americans approve of Congress' performance. Another showed most Americans would vote out every member of Congress, regardless of party, if they had the chance.

The amazing thing about that statistic: They do have the chance. They can vote.

Yet so many choose not to. In last year's elections, just 37.8% of the voting-age population made it to the polls. Thirty million more votes were cast for last season's American Idol than for last year's Congressional election.

Think about that. The majority of those who disapprove of Congress' performance don't even bother to vote. These people have very little right to complain, in my view.

If you're sick of what's been going on lately, and appalled about the debt downgrade and its impact on your investments, do something about it. Vote.

Fool contributor TMFHousel. The Motley Fool owns shares of JPMorgan Chase. The Fool owns shares of and has opened a short position on Bank of America. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Deal or no deal? US downgrade looking likely (AP)

NEW YORK – Could the U.S. lose its top credit rating even if a deal is reached to raise the debt limit? Market analysts and investors increasingly say yes. The outcome won't be quite as scary as a default, but financial markets would still take a blow. Mortgage rates could rise. States and cities, already strapped, could find it more difficult to borrow. Stocks could lose their gains for the year.

"At this point, we're more concerned about the risk of a downgrade than a default," said Terry Belton, global head of fixed income strategy at JPMorgan Chase. In a conference call with reporters Tuesday, Belton said the loss of the country's AAA rating may rattle markets, but it's "better than missing an interest payment."

Even with a deadline to raise the U.S. debt limit less than a week away, many investors still believe Washington will pull off a last-minute deal to avoid a catastrophic default. Washington has until Aug. 2 to raise the country's $14.3 trillion borrowing limit or risk missing a payment on its debt. President Barack Obama and Congressional Republicans have failed to reach an agreement to raise the debt ceiling and pass a larger budget-cutting package. Politicians have tied raising the debt limit and spending cuts together.

But at least one credit rating agency has already made it clear that unless that agreement includes at least $4 trillion in budget cuts over the next decade, the country's AAA rating could be lost. Right now, the proposals under discussion cut around $2 trillion or less.

Standard & Poor's warned earlier this month that there was a 50-50 chance of a downgrade, if Congress and President Obama failed to find a "credible solution to the rising U.S. government debt burden." S&P said it may cut the U.S. rating to AA within 90 days. Passing a $4 trillion agreement could prevent a downgrade, S&P said.

The other chief rating agency, Moody's Investors Service, said the U.S. government would likely keep its top rating if it avoids a default.

Spokesmen from both Moody's and S&P said they wouldn't comment beyond their recent reports.

JPMorgan's Belton said clients have started asking how markets will respond if the U.S. loses its AAA rating. A drop to AA will mean permanently higher borrowing costs for the U.S. government, he said. And because government lending rates act as a floor for other lending rates, mortgages, student loans, corporate debt and other types of loans will become more expensive.

Belton estimates that borrowing costs would rise between 0.60 to 0.70 points. That may not sound like much. But mortgage interest rates, which have hovered around 4.5 percent for the last several weeks, could rise by at least that amount, to more than 5.1 percent.

And for the federal government, it eventually means an extra $100 billion in interest payments to Treasury holders like China each year.

"That's a huge number," Belton said. That $100 billion a year that could be spent elsewhere on everything from education to infrastructure.

An increase in interest rates could soon become a drag on other parts of the economy, experts say. State governments and insurance agencies would also be downgraded — and states are already having financial troubles. Business confidence could sink again, leading to prolonged high unemployment.

But some investors aren't unhappy about the thought of a U.S. debt downgrade. Don Quigley, manager of the $1.5 billion Artio Total Return Bond fund reasons that such a move could provide a buying opportunity. He believes that a downgrade would immediately send the yield of the 10-year bond up to 3.15 percent from its current level of about 3 percent.

If the economy sinks further in part because of higher interest rates, investors would very likely return to buying bonds, Quigley said. That's what they've done during the last several years both during the financial crisis and recession, and again the last several months as the economic recovery has slowed.

Treasurys would keep their allure, in part, because there are few alternatives for large foreign buyers looking for a market big enough to handle massive investments.

"The German market is not big enough and Japan has its own problems," Quigley said.

A cut to the U.S. credit rating could hit stocks harder than bonds. A study by Janney Montgomery Scott looked at rating changes to countries over the past decade. After Spain was downgraded in 2009, Spain's stock market fell 8 percent in three months. A cut to Japan's credit rating in 2011 knocked the country's stock market down 3.4 percent in three months. The study, released in April, suggested the S&P 500 would fall 6 percent after a U.S. downgrade, erasing all its gains for the year.

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S&P threatens downgrade of U.S. financial companies (Reuters)

NEW YORK (Reuters) – Standard & Poor's on Friday raised the pressure on debt negotiators in Washington, saying it could downgrade insurers, securities clearinghouses, mortgage agencies and a laundry list of other firms without a deal soon to lift the debt ceiling and cut the deficit.

While S&P had already made clear it could downgrade the United States' sovereign credit rating, the Friday move struck directly at the heart of the financial system, raising the prospect of knock-on effects should the country exhaust its ability to borrow to pay bills.

The Treasury took the last available step Friday to try and extend that borrowing capacity.

S&P on Friday put on review for possible downgrades a range of powerful financial firms -- many of them little known to the public but crucial to the country's financial infrastructure. U.S. government securities are central to the operations of most of the companies cited.

They include the Depository Trust Co, which facilitates payment transfers among major banks, as well as several Federal Home Loan Banks and Farm Credit System Banks. They also singled out Fannie Mae and Freddie Mac, the two government-sponsored enterprises that are central to the residential mortgage market.

S&P characterized its targets as "entities with direct links to, or reliance on, the federal government."

Separately, the agency said the four remaining U.S. nonfinancial companies with triple-A ratings were not affected by the downgrade threat.

'WARNING SHOT'

"S&P is firing a warning shot, saying the entire financial clearing system is in question," said Peter Niculescu, a partner at Capital Markets Risk Advisors, a risk management advisory firm in New York.

He raised the prospect of a financing squeeze for financial institutions if Treasury debt is downgraded. S&P said Friday it still sees the risk of default as "small, though increasing."

Nik Khakee, an S&P analyst who worked on the team assessing the clearinghouses, emphasized that the decline for the triple A-rated companies from "outlook negative" to "creditwatch negative" -- signaling a 50 percent chance of a downgrade within three months -- directly follows a similar change for the debt of government securities.

Earlier this week, Moody's also put its U.S. credit rating on review for a possible downgrade.

Some investors downplayed the chances of a severe market reaction if the United States is downgraded, given that the market has known this could be coming.

"Do you think China is going to sell all their Treasuries when they find out the ratings are lowered? They know the situation, they've known it all along," said James Melcher, founder and president of Balestra Capital Ltd, a global-macro investment manager based in New York. "They cannot sell a significant amount of their Treasuries without running interest rates up to 20 percent or more; they would be shooting themselves in the foot."

ONUS ON WASHINGTON

Many of the firms put on review for a possible downgrade were quick to turn the focus back on President Barack Obama and the congressional leaders trying to hash out a deal to stave off a debt default.

"Whatever happens will have nothing to do with us, and everything to do with Washington. The hope on everyone's part is obviously that Washington gets its act together so that both their rating and ours can remain where they belong -- at AAA," said Patrick Korten, a spokesman for insurer Knights of Columbus, which was included on the negative watch list.

A spokesman for Goldman Sachs, parent company to Goldman Sachs Mitsui Marine Derivative Products LP, declined to comment. A spokesman for New York Life said S&P told it no financial institution can carry a higher rating or outlook than its sovereign rating, and that the insurer believes its rating to be fully justified.

Northwestern Mutual said it remained "completely confident" in its financial strength.

Other insurers on the list were not immediately available to comment.

Another broad group in S&P's sights is the clearinghouses, which guarantee contracts tied to everything from oil contracts to shares of Google Inc and are critical to U.S. financial market stability.

"It's not unexpected and we don't see this as a reflection on how OCC conducts its business," said Jim Binder, spokesman for the Options Clearing Corp, which clears U.S. options or futures for 14 exchanges. "It's all about what's going on in Washington."

The U.S.-based Depository Trust & Clearing Corporation, which provides custody and asset servicing for more than 3.6 million securities issues from the United States and 121 other countries and territories, valued at $33.9 trillion, said the S&P action was expected.

"Changing the outlook on various financial institutions is common practice for ratings agencies when the outlook on a sovereign is changed," DTCC said in a statement. DTCC runs the National Securities Clearing Corporation and the Depository Trust Company.

Freddie Mac also declined to comment. Fannie Mae did not immediately respond to requests for comment.

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S&P warns it may downgrade Fannie, Freddie credit (AP)

WASHINGTON – Standard & Poor's warned mortgage giants Fannie Me and Freddie Mac on Friday that they may lose their top credit ratings if lawmakers don't raise the U.S. government's borrowing limit in time to avoid a default.

S&P said government-controlled Fannie and Freddie, along with certain Federal Home Loan Banks and Farm Credit System Banks, could also default on their debts, given each institution's "direct reliance on the U.S. government."

The rating agency this week threatened to lower the U.S. government's credit rating if the White House and Congress can't agree to raise the $14.3 trillion borrowing limit and avoid a default in the coming weeks. It said there was at least a one-in-two likelihood that it will lower the rating within the next 90 days.

On Wednesday, Moody's Investors Services said it is also reviewing the government's triple-A bond rating.

The government reached its borrowing limit in May. The Treasury Department has said that the government will default on its debt if the limit isn't raised by Aug. 2.

Congressional and Obama administration officials met for a sixth day Friday in an effort to avert a default. But Obama conceded that "we're running out of time."

Attention has turned to a fallback plan being discussed by Senate Republicans and Democrats. The plan would give the president greater authority to raise the borrowing limit while setting procedures in motion that could lead to federal spending cuts.

Administration officials and economists say a default on the debt would have a devastating effect on the U.S. economy.

Federal Reserve Chairman Ben Bernanke told a Senate panel this week that a default would force the federal government to pay higher rates on its debt. Treasury rates serve as the benchmark for many consumer and business rates, including mortgages. So higher government rates would raise borrowing costs for consumers and businesses.

Fannie and Freddie own or guarantee about half of all U.S. mortgages, or nearly 31 million home loans worth more than $5 trillion. As part of a nationalized system, they account for nearly all new mortgage loans. So anyone looking to buy a home would be forced to pay higher rates on new loans.

The Bush administration seized control of the mortgage giants in September 2008, hoping to stabilize the beleaguered housing industry. The Federal Housing Finance Agency has acted as regulator, overseeing it as calls for the gradual dismantling of both companies have increased.

Taxpayers have spent roughly $150 billion to rescue Fannie and Freddie, the most expensive bailout of the 2008 financial crisis. The government estimates the final cost for rescuing Fannie and Freddie could go as high as $259 billion.

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