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Much ado about nothing!

US downgrade, should we panic?

Written By: WGC - Apr• 22•11

Standard & Poor, the ratings agency this week re-assigned America’s credit rating from stable to negative. In English, this suggests that the US is in trouble. Is it really that much in trouble that its credit rating has been downgraded for the first time in 70 years?

This timing of this move is surprising because Obama has been reluctant to follow the austerity measures being adopted by a lot of Europe’s bigger economies all along, yet he now has had a change of heart. The bi-partisan nature of American politics suggests that Obama will struggle to get agreement by congress, however good his plan. The healthcare bill “battles” bear testimony. Is this why the Standard & Poor has acted this way? If that is the case then this raises questions on the credibility of these ratings. It appears speculative rather than based on fact, which you think it should be.

For clarification, Americas’ credit rating is still AAA, however, the negative outlook means there is a one in three chance it will be downgraded in two years. It is interesting to note that the effect of this news on the market was only a temporary lull and it soon recovered. What was even more odd was that bond yields decreased. It would not have been surprising to see more panic across markets given what Greece and other European countries with fiscal problems have gone through. A plausible reason could be that this served warning .As a result, action would finally be taken to reduce the deficit from its current levels of around 100% of GDP. Hence the markets view this as positive.

However, despite all the headlines this news created, we should not forget why America is in fiscal turmoil. The financial crisis has been largely blamed on the subprime mortgages which originated in America  and the associated  complex derivates. Whilst greed and excessive risk taking or lack of adequate regulation can be blamed, let us not forget the rating agencies. The financial world relied on these rating agencies and this trust was misplaced. If the rating agencies had rated those toxic assets correctly maybe they would not have been any financial crisis to talk about or perhaps less severe.

That is why perhaps we should be sceptical about the negative outlook on the credit rating of the world’s largest economy. The credibility of the ratings agencies was severely harmed by the Global financial crisis.

 

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