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Saturday, August 06, 2011

Answers to Barry Ritholtz's 10 questions about S&P downgrade

Barry Ritholtz asks 10 questions about S&P downgrade and I answer most of them below:

Here it goes:

1. The change in trajectory of US debt was in service of Banks: It began with TARP, and continued with every other bailout/stimulus/economic plan. What was S&P’s role in creating that crisis?
 S&P is centrally responsible. So are US regulators, banks and those crying hoarse. Let us remember there is plenty of blame to go around for GFC. 
2. How will non-US investors (Private and Central Banks) view the downgrade?
Most non-US investors already discount the news. However, investment strategies will compel some to act if another agency downgrades.  
4. What does the downgrade do to US currency — is that the true impact of the credit downgrade?
Over 5 year horizon I think USD will begin to decline. A declining dollar is in the interest of US. It will reinforce US manufacturing. Immediately, though, flight to cash and commodities seem to be possible options.  
5. Will borrowing costs likely increase for the US? What about consumers?
Borrowing costs for US entities will increase. I suspect the ability to pass on these cost to consumers will remain under pressure. Consumer rates, after accounting for all adjustments, a quite high. It will impact borrowing cost of investors, leverage will be difficult to come by.   
8. Why did the rating agency not wait until the special committee / debt ceiling deal was completed later this year?
I think the rating rationale was more political than financial – more related to “willingness to pay” rather than “ability to pay”. The debt committee would have done more related to “ability to pay”. The statements by politicians about “debt ceiling debates hereafter should be conducted this way”, “maybe default is a good option” etc. makes one really skeptical of US governance. You see such things in banana republics not US – definitely not a behaviour of AAA rated sovereign. 
9. The Rating Agencies were downgraded by Dodd-Frank, with all regulatory and legal references to be removed. Was S&P’s move retaliatory?
I don’t think so.  
10. How will US markets open on Monday in response to the downgrade?
Move to cash and commodities could be a good idea to bet on. Though one can never be adequately sure.