The big news this week came when the rating agency Standard & Poor’s downgraded its outlook on long-term US debt on fears that the United States’ budget difficulties may lead the Treasury to default on some of its bonds.
This news, of course, sent shockwaves through financial markets, knocking major stock industries down several points upon release. The sentiment – and portfolios – of many investors around the world changed very quickly with this action by S&P.
S&P’s decision to downgrade its outlook on long-term US debt comes on the heels of Treasury Secretary Tim Geithner’s warnings that a failure by Congress to raise the debt ceiling could result in a default on government debt.
In other words, Mr. Geithner is warning Congress that the United States’ national debt has grown so large that the Treasury can no longer afford to service that debt without taking on additional debt. Sound idiotic? That’s because it is.
First, Mr. Geithner, in his infinite wisdom, is pretending that he lacks any other mechanisms for servicing US debt. Monetization stands out as one viable option; and while the resulting inflation would be far from ideal, it beats the heck out of default, which would cripple this nation’s credibility in international markets.
Then again, Congress could always cut back on spending and gradually reduce the national debt over time. Unfortunately, this makes entirely too much sense to be a desirably path for politicians in Washington. Plus, they’d surely lose votes if they started cutting funding and spending on various less-than-necessary programs.
Despite Geithner’s repeated warnings, which are unlikely anything more than empty threats anyway, it would appear that the ratings agencies may be overreacting – which is certainly understandable. After all, S&P, et al can hardly afford to appear incompetent after they failed to correctly assess the risk in all those pesky mortgage-backed bonds and derivative securities that largely contributed to the market crash in 2008.
To borrow an interesting turn of phrase from Mr. Obama’s predecessor that seems to characterize the dilemma facing ratings agencies, “fool me once, shame on you. Fool me… you can’t get fooled again.”
From an investment standpoint, the S&P downgrade on long-term US debt amounts to little more than noise in the market. The news, though big for headlines, did not fundamentally change the world. The threat of default by the US government has always existed; so one ratings agency’s lack of confidence shouldn’t mean much.
More importantly, investors certainly shouldn’t be making investment decisions based on this event alone. Obviously this news represents another factor to be considered, but it shouldn’t be leading investors to change their outlook on the fundamentals of this market or the economy.
