STRIPPED: What the Credit Downgrade Means

I wrote about a possible credit downgrade on July 28th and split the probable reactions and consequences into what should happen and what (most likely) will happen. Lately, and with good reason, we’ve all become conditioned to the idea that what actually happens in the financial markets is not what should be happening.

Take this latest move. Nothing that the S&P has done by downgrading US long-term debt obligations from AAA to AA+ has done anything to change the fundamental math of the equation. The US is just as insolvent after the downgrade as it was before the downgrade.

But in a fiat money system, faith is very important, and what just took a big hit was the perception of safety that surrounds US Treasury debt. Further, the downgrade came at a rather awkward time for the financial markets. I suppose there’s never a great time, but some times are a little worse than others, and the financial markets are already highly unsettled after a few weeks of piss-poor economic data signaling the arrival of another downturn and a rising debt crisis in Europe that is still devolving rather than healing.

Here’s a good reader observation and question to which I’d like to respond:

To be honest I’m kinda surprised S&P actually pulled the trigger on the downgrade… I figured it was more likely they’d wait until just AFTER the next crisis (’08-style near-implosion or major bond vigilante action). I just don’t know how significant an impact can we expect from S&P’s downgrade given the other major ratings agencies have yet to downgrade the US.

My question to Chris is, does this change your assessment of the timeframe, areas of risk, and/or degrees of impact in your ‘Rout’ probable outcomes and expectations? 

(…)

Thanks, Nickbert

I, too, was surprised that S&P had the moxie to strip the US of its top credit rating (for long-term debt) and by the fact that it took it down to AA+ in one move while also slapping a negative watch on there to boot. (See definitions of credit grades and what a “watch” means at the bottom of this article).

While this is big news this weekend, its main impact is largely symbolic. Nobody should really be relying on rating agencies anymore, after their abysmal performance beginning with WorldCom, Enron, and then the subprime fiasco.