By JACK HOUGH
Standard & Poor's lopped an A off America's credit rating late Friday, ending the nation's 94-year streak as a triple-A borrower. A reading of the downgrade note suggests that if it could have, S&P would have left the country with a pristine score for its ability to pay at the moment, while dropping it to junk on the competence of its policy makers to address long-term challenges.
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"The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed," the note read.
The timing was kind, giving investors the weekend to think over what a downgrade means. It seems few investors will be forced to sell Treasurys. As I noted last month ("S&P, Moodys Downgrade Irrelevant"), a Wells Fargo economist who studies the matter found no large government bond mutual funds that are bound by prospectus to hold AAA-rated paper--and mutual funds, anyhow, hold just 7% of Treasurys. Also, the Fed says the downgrade doesn't change its risk weights for Treasurys, meaning banks that hold Treasurys as capital won't have to put up more money. Other lenders might not be as generous as the Fed, however.
Whether Treasury holders will want to sell in large numbers is another matter. Japanese officials told the Wall Street Journal that Japan's faith in U.S. debt remains strong, and they own more of our debt than any country but China. And it's worth remembering that S&P first announced its intentions in April, and Treasury demand has only increased since then, pushing yields to historic lows. Short-term bills briefly traded with negative yields during last week's market turmoil, meaning some buyers paid rent for the refuge of Treasurys.
For any other borrower in the world, a credit downgrade would mean a jump in interest rates. But ironically, America's titanic debt is a selling point to big-money investors with vast sums to safeguard. Before Friday, it had more than $15 trillion in AAA-rated issues outstanding, including Agency mortgage securities. The next-biggest AAA debtors have less than $2 trillion. That makes the U.S. an unmatched source of liquidity.
Nonetheless, expect Treasury yields to rise in the short term. They can hardly fall more, after all, and smaller investors might seek out alternatives. Odd as it seems, four nonfinancial U.S. companies retain AAA ratings and thus are deemed better for the money than the U.S.: Automatic Data Processing (ADP),
Stock investors are more easily rattled than Treasury holders, so the downgrade might be a bigger deal for the Dow. Shares of three of the aforementioned companies, Exxon, J&J and Microsoft, are just the sort that investors should jump on if prices fall more. These companies have stable earnings, modest valuations and yields that beat anything on offer from the Treasury, considering the ability of dividends to grow with earnings over time.
In the long run, the downgrade will hopefully make voters properly angry. It would have been worse if Washington's dangerous clownery of the past month had brought no consequences. The challenges facing the country aren't nearly as grave as they're made out to be, and the fixes aren't especially painful. Costs for defense and healthcare, the two biggest sources of bloat, must be slashed. Social Security needs a higher retirement age at minimum and means testing at most. The $1 trillion of spending hiding in the tax code must come out; capping tax breaks at 2% of income is a good place to start. These and similar reforms aren't right-leaning or left-leaning. They're math-leaning. It's time for policy makers to drop the dogma and start using the same cold calculus as S&P.