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Further Thoughts on S&P’s Downgrade of USA

Posted by Larry Doyle on August 8, 2011 7:44 AM |

The sun did come up here on the east coast this morning. That is a very good thing. Life does go on.

Our fiscal life goes on as well. In many respects it is little changed but in others it is very much changed and will not soon be restored. As the emotions of many inside and outside of the markets are frayed as a result of S&P’s downgrade of the USA, let us keep our heads and maintain our ‘sense on cents‘ approach.

On that note, what are three questions I see many asking and how would I respond to them?

1. If the USA just had its credit rating downgraded, then why aren’t US Treasuy rates moving immediately higher as a result?

Our interest rates are a function of many factors not just our credit rating. What other factors?

>>Primarily the pace of economic growth and the projections for future growth. The economy is perceived to be slowing and the chance of a double dip recession is increasing. I personally believe the recession we entered in late 2007 never truly ended and that the pop in the economy was predominantly a function of short term and unsustainable government stimulus. A slowing of the economy portends low rates …and the Fed will certainly continue to keep short term rates low for an extended period.

>>With the slowing in our domestic and global economy, the threat of deflation or disinflation within our real economy increases. This topic is getting little air time but it should not be discounted. The dreaded “D” —as in deflation or disinflation— will hold down our interest rates.

>>Let’s be honest, our Treasury market has been very heavily manipulated by the Federal Reserve via its quantitative easing programs. The European Central Bank is now engaging in a similar exercise trying to support the Italian and Spanish bond markets.

I do believe the biggest move in our US Treasury market over the longer term will be a steepening of the curve, that is, short term rates will remain low while longer term rates gradually move higher.

This reality will negatively impact most savers and borrowers. How so? Rates on CDs and assorted other short term investment products are tied to short term Treasury rates and will remain low. Rates on mortgages are predominantly tied to longer maturities and thus OVER TIME will move higher from where they are today.

These projections on rates are independent of another round of quantitative easing by the Federal Reserve.

2. What about Standard and Poors? Are they out of line with this downgrade?

For Tim Geithner and others within the administration and Congress to cast aspersion at Standard and Poors is a joke. The fact is S&P downgraded the outlook for the US to negative last April and then put the US on negative watch in mid-July.

The reality of an actual downgrade may have surprised some who are merely used to “the boy who cries wolf” approach in Washington but the simple fact is that “big, bad wolf” is clothed in the debt of the USA and it is both very real, very large, and very mean.

Since April, how often have Tim Geithner and his sidekicks in Treasury spoken to the crowd at S&P? If they were not speaking to them on a regular basis and comparing notes and numbers, then I believe they were negligent in performing their duties. Spare us the histrionics Tim.

3. How do we move forward in a truly meaningful fashion?

In summary, our fiscal nightmare will only be addressed with meaningful reform within our entitlement programs and our tax policy and structure. Everything else is important but will not ‘meaningfully move the needle‘.

Additionally and no less important, I firmly believe we need to exorcise the debilitating and corrosive incestuous relationships which Washington fosters with a wide array of constituencies. I believe this badly needed exorcism will only occur as a result of imposing strict term limits.

For those who have not read my immediate reactions and opinions on the market and economy to this HUUUUGE story, I am happy to provide a link to Breaking News: S&P Downgrades United States.

Questions, comments, constructive criticisms always encouraged and appreciated.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.



  • Cate

    You are spot on Larry as usual. Compared to Buffet’s comments (no comparison) where he ‘just doesn’t get it’ and firmly believes the US is still AAA in his book. Just more evidence the old man is out of touch and really needs to be sent out to pasture where he can do no more harm with his Oligarch non-wisdom nonsense.

  • fred


    Have you seen Moody’s commentstoday. A downgrade by Moody’s is contingent on an extension of the Bush tax cuts.

    I would agree that something has to be done on the revenue side, but should Moody’s be taking such a devisive political position?

    Are the ratings agencies becoming soldiers of the major political parties or is it just Moody’s that is crossing the line?

  • LD


    I did not see that specific statement yet but I do believe that is very bad form.

    IMO, a rating agency can clearly state that there is real need to address the major structural issues underlying the out of control debt and deficit. I do not mind S&P referencing the dysfunction in Washington as a concern.

    Specifically referencing an individual tax program or policy strikes me as ‘going over the line.’ That is dangerous.

    Is this the next development in the ‘unintended consequences’ of crony capitalism? Would seem that it may very well be.

  • Peter S.

    “Raters Draw SEC Srutiny” June 17, 2011

    “The Securities and Exchange Commission’s long-running probe into the deals has widened to the major credit-rating firms, including Standard & Poor’s, the people said.”

    Raters Drawing SEC Scrutiny

    Pay back is a b#%ch.

    • LD


      You know this is nothing more than the standard Chicago-style policy emanating from the Obama White House.

      While the SEC is now going after the ratings agencies, where were Barack, Timmy-boy, and Mary back in 2009.

      Let’s rewind the Sense on Cents tape and review what I wrote back in mid-2009, Wall Street’s Great Enabler Dodges a Bullet,

      Did Barack Obama and team give a sly and subtle wink to Wall Street that ‘the game goes on’ and the ‘fix is still in?’ I believe they did.

      Many analysts, myself included, view Obama’s proposed regulatory reforms as a combination of ‘reshuffling the deck chairs’ and ‘cosmetic surgery.’ In the process of those maneuvers, the rating agencies – Wall Street’s Great Enabler – went largely untouched.

      The rating agencies business model presents massive conflicts of interest for all involved. The greatest conflict centers on the fact that the rating agencies’ stream of revenue remains beholden to the Wall Street banks. Without addressing that issue, any dialogue on this topic holds no water.

      The Wall Street Journal does yeoman work in highlighting the continuation of the Wall Street charade in this area in writing, A Triple AAA Punt:

      If world-class lobbying could win a Stanley Cup, the credit-ratings caucus would be skating a victory lap this week. The Obama plan for financial re-regulation leaves unscathed this favored class of businesses whose fingerprints are all over the credit meltdown.

      How is it possible in the midst of such a massive financial meltdown that Obama, Geithner, and team could leave this critically important piece of the regulatory puzzle untouched? Actually, it is quite simple.

      As with any heist, the perpetrators need a ‘bag man,’ who will take a payoff while providing cover to the operation. This scenario with the rating agencies is a prime example of How Wall Street Bought Washington.

      Obama is flexing his muscles for the public, but without changes within the rating agencies the signal to Wall Street from Washington is that it is ‘business as usual.’ The WSJ offers as much:

      The Obama plan does make plenty of vague suggestions, similar to those proposed by the rating agencies themselves, to improve oversight of the ratings process and better manage conflicts of interest. The Obama Treasury has even adopted the favorite public relations strategy of the ratings agency lobby: Blame the victim. “Market discipline broke down as investors relied excessively on credit rating agencies,” says this week’s Treasury reform white paper. After regulators spent decades explicitly demanding that banks and mutual funds hold securities rated by the big rating agencies, regulators now have the nerve to blame investors for paying attention to the ratings.

      Sense on Cents believes strongly we need transparency and integrity in the regulatory process. What Obama has delivered in this key area are ‘vague suggestions.’

      Am I surprised? No. Once again, the American public at large and investors specifically are subjected to ‘business as usual.’


      Perhaps Barack and team may say that they had too much on their plate back then as they worked to formulate financial regulatory reform. I do not buy it. They should have addressed the rating agencies back then. To do so now is blatantly political and it smells.

  • Dieter

    Great article Larry. As usual, the media is trying to kill the messenger rather than listen to the message. We’re sorry to see this as it won’t help America move toward a solution. Looks like more rough road ahead.

  • Cate

    And now Moody’s says they’ll downgrade if it deems deficit cuts ‘not credible’ . . . uh, what are they waiting for?

  • Matt Cornell

    Hi Larry –

    On another topic, what are your thoughts on what is going on with Bank of America today? AIG has filed a big lawsuit against them (ironic), their stock has crashed in the last three days, they are one of the too big to fail banks, but right now after the S&P downgrade is the Treasury or the Fed really able (or willing) to bail them out again? If not, and I don’t want to freak people out here, but does the FDIC really have enough money to cover deposits for Bank of America if they were to fail? What do you think will happen with them?


    • LD


      I have no doubt that Bank of America will need to raise more capital and the markets are effectively stating as much as the IPO would further dilute current shareholders.

      I do not know the current status of the FDIC reserve fund. I do not think the government is yet ready to unwind a firm of that size although I think that BoA should be broken up.

      The simple fact is despite two plus years worth of $$ and effort the banking system remains fundamentally broken and is still capital constrained. IMO, BoA is largely a reflection of the US housing market and the American consumer.

      The bank will be in tough shape for a long time to come.

    • fred

      AIG has credit default swap exposure/liabilities due to MBS issued by BoA with underlying mtgs underwritten, for the most part, by Country Wide Credit. I’m sure AIG’s legal position is that these mortgages were fraudulently underwritten.

      Is this the next act in the soap opera? What’s the leverage exposure in a credit default swap? Whre’s the exposure? CDS were issued on both sovereign debt and MBS (both highly toxic).

      How can a country like Greece default, won’t the EU step in? How can a MBS fail, aren’t they backed by the full faith and credit of the U’S. gov’t?

      Back in 2009, I was expecting BoA to “raise” capital through a forced merger with Citi, the next big “weakest” bank on the creditor “hit list”. (didn’t happen then, maybe it will happen now).

  • LD


    Only GNMA MBS are backed by the full faith and credit of Uncle Sam. The mortgages in which AIG is involved are most likely not GNMAs and thus not backed by Uncle Sam’s full faith and credit.

    Freddie and Fannie MBS have the implicit backing of Uncle Sam and to the best of my knowledge the Chinese TOLD tim Geithner that these securities were backed by Uncle Sam, weren’t they??!!

    Countrywide underwrote predominantly non-agency mortgages which had a measure of credit support in the structure of the deal but no implicit or explicit backing of the government.

    No doubt there was real fraud in the underwriting and packaging of these mortgages. Now we have incestuous fighting for $$ as AIG which is still largely owned by Uncle Sam goes after an entity, BoA which operates under the thumb of the government. Call it FAMILY FEUD….with the taxpayer ultimately getting stuck with the bill.

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