Capco Blog

Does anyone really care anymore what S&P says, or is it simply an excuse everyone needed to bring about another recession

The recent reactions by the world to the announcement that S&P has downgraded the U.S. government’s credit rating reminds me of what happened when Dubai announced that it will not be able to pay back the debts that some of its businesses had taken on during the good days. Anyone who bothered to look knew that Dubai will not be able to meet its huge debt obligations without the help of the bigger brother down south, namely Abu Dhabi. The same goes for the U.S. We have learned nothing new about the status of the U.S. debt as a result of the rather funny discussions that took place between the Congress and the President that we did not know already. We have certainly learned nothing new as a result of S&P’s downgrade. Remember, these are the same institutions that had kept Fannie Mae and Freddie Mac’s AAA ratings long after everyone else knew that the firms are having serious problems.

This time the rating agencies have once again proven that they have bad timing. In order to not seem to have been too harsh on Italy, they have now downgraded the U.S. Does anyone really believe that the U.S. will now be required to pay more interest on its borrowings? Or, has the risk of a U.S. default really increased since last week. If so, then why downgrade to a AA+, why not BBB? Just how much more risky is AA+ from AAA? Do the people at S&P even know what that is? Those who actually understand risk know that it can’t in anyway be accurately calculated, and even if they did, just how much more risk does a move from AAA to AA+ mean. View our paper on risk.

If it was simply meant as a gesture on the part of S&P, which it can’t be anything but, then why do it now? Why do it at a time when the world least needs it. It will certainly not impact the U.S. government’s cost of borrowing, but it could have detrimental implications on those institutions that hold dollar as reserves in order to meet their capital requirements. The implications of such a downgrade could be huge, and no one really knows just how huge. Certainly not S&P.

The likelihood of the U.S. dollar being replaced as the world’s major reserve currency has not increased at all since the recent bickerings between the Congress and the President. It has certainly not increased as a result of the S&P downgrade, no matter what China says. Consequently, all the U.S. needs to do to pay off its debts is to turn up the speed on its currency printing machines.

So, what has the downgrade achieved? In my opinion, it might have just helped Western economies get slightly closer to a recession, since as I said no one really knows how the downgrade will impact those financial institutions that have used dollars as reserves. If they are required to recapitalize, then the small stream of lending to the corporate sector that we have witnessed in recent years might come to a complete stop. It might also put off those companies that have been increasing their cash reserves from investing and hiring more people. Just at the time when the world can least afford it.

So, all in all, while S&P missed the last crash, it might certainly have helped bring about the next one. A completely unnecessary and ineffective decision that has no direct impact on the U.S.’s borrowing capabilities or cost of funding, but meets all the criteria of unintended consequences.

On a more positive note, it might also result in the establishment of rating agencies that actually understand what they are doing. We live in hope.

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