After what was a devastating week for many stock market investors, US Treasury credit was downgraded on the night of Friday, August 5, by Standard & Poor’s. It was knocked down a notch from the highest rating, AAA, to AA+. According to a New York Times article quote, Standard & Poor’s made the statement, “The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge.” While there have been several warnings and much talk of the possibility of a downgrade, the markets certainly reacted negatively to the nature and timing of S&P’s decision. 

S&P’s decision to do this downgrade stems from legitimate concerns about the direction the US government seems to be headed in: the increase in the debt ceiling hasn’t been accompanied by enough spending cuts to lower our high debt to GDP ratios, and political figures seem unwilling to take the unpopular or difficult stances needed to address this problem. These issues are undeniably systemic ones that cannot be solved over night.  There seems to be good reason for S&P to be concerned about the long term fiscal picture.

However, when it comes to the markets, timing truly is everything. Coming off one of the worst weeks the markets has seen in a couple of years, and months of Armageddon rhetoric on the news, a rating downgrade could not have been more untimely.  It felt like this was the straw that broke the camel’s back:

Stocks tumbled in reaction to S&P’s credit downgrade. The drop was so severe, it rivaled some of the worst declines we’ve seen over several decades and reminded an already skittish market about the crash of 2008. All the same, as significant as the downgrade was for domestic and global economies, we believe that the response of the markets was an overreaction, due in most part to fear. It is probably true that this debt downgrade, in reality, will not be as significant as the idea of the debt downgrade will be, due to its severe representation in people’s minds. After all, for our debt to be downgraded for the first time, on top of an already struggling economy, on top of a global economy where most regions are already facing a lot of trouble, this certainly does not act as an indicator of positivity for investors. However, most likely, we will see that the Treasury downgrade and its fairly devastating impact on the markets, after an already unimpressive week, was a correction. Although a credit downgrade of the world’s largest economy is unprecedented, we have seen this sort of thing happen in the markets before, and we believe that with time and regained confidence, more realistic and accurate pricing will take over.

We believe that the response Americans saw from Washington was lacking in both leadership and initiative. Again, while we concede that S&P’s timing may have been harsh, the government seemed unable to take any responsibility for moving forward in an effort to fix what is now very clearly broken about our fiscal environment. This is not the time for a divided US government to be pointing fingers at the ratings agencies, but rather to join together, face the music, and namely, the fact that the line has been drawn, and our borrowing and spending have got to stop.

Despite a troubling week in the markets, at the end of the day, the state of our economy is more important than the rating we have been given by one major credit rating agency. Although it may seem like things couldn’t get much worse at the moment, there are still indicators of positive growth, and as a result, chances of recession are low. We truly believe this is a short term crisis that will work itself out in the longer run. Our fundamentals will continue to improve slowly, led by still high corporate earnings, better unemployment statistics, and support for the dollar from emerging markets and those countries with a vested interest in keeping our currency afloat. The dollar remains the world’s reserve currency. Therefore, even if US credit is not technically where it was a year ago, it is still in better standing, and more powerful standing, than anything else. Furthermore, bond rates actually declined. In addition, it is appropriate to conclude at this time that finally, policy makers have no choice but to confront this issue. Whereas before it seemed government was still waiting for the final straw, it is unlikely that we will be able to sit back and wait any longer, with threats of further downgrades and the consequences of our behavior thus far.