What does the S&P’s AAA to AA+ downgrade for the United States mean?

If you haven’t heard the news, S&P just downgraded us from AAA to AA+ and gave us a negative outlook to add insult to injury. But it’s not like we didn’t deserve it. In a democracy, people deserve the government they get. Remember that “We the people…” document? Well we the people just got a AA+.

It’s the first time the US has been downgraded since we received a triple-A rating from Moody’s in 1917 and a AAA from S&P in 1941.

Obama says “S&P’s analysis of the United States economy is deeply flawed.”. I think his chances of reelection just got deeply f***ed.

Keep an eye on treasury bond yields on Monday morning. There’s a tension between interest rates going up since they’re now technically more risky and the reflex flight to risk causing treasury buying that drives their rates down. It’ll be interesting to see whether fear or common sense prevail.

So what will happen going forward?

  • Interest rates in this country are bound to rise long term because, what the government pays on debt is the base of all other interest rates in the country.
  • Mortgage rates rising won’t help the housing market “recovery”. Less people will buy houses with the cost of borrowing becoming more expensive.
  • With asset prices falling a few more banks will fail. Their debt to asset ratio will not meet the minimum requirements and the FDIC will show up on Friday afternoon and seize them.
  • Expect to hear about the FDIC fund running short on cash and there to be a vocal debate about how to replenish it. Technically it’s an insurance policy that the banks fund and in normal times the government might just top it up. But what will probably happen as the fund gets depleted is that they will need to raise the rates they charge banks, which may make banking in this country more expensive for consumers and businesses.
  • The latest budget debate made it very clear there will be no more trillion dollar bailouts. The good news is that at least this kills moral hazard (when bankers and execs are irresponsible because they know they’ll get bailed out.
  • It gives us a reasonable facsimile of a free market. Even if you’re going to have to dodge the falling bodies on Wall St….
  • The dollar will fall as foreign investors move to countries like the UK, Germany, France and Canada who all still have their AAA rating intact.
  • Companies that rely on cheap foreign labor or resources will have to radically restructure their supply chains to survive and some might not be able to pull it off.
So where are the opportunities? Well I’ve said it before and I’ll say it again: “Gold prices will hit $1800 in September/October and $2200 or more by year end.
  • Companies that export US goods or services will earn more as the dollar falls.
  • Technology companies who are nimble, efficient and export services will do well.
  • New innovators will replace incumbents who can’t readjust.
  • We might get a new political party in the next half decade.
And for a laugh.. the Federal Reserve just announced that risk weightings for US government securities (how risky the government thinks it is) will remain unchanged:
For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

And finally, lets hope that 500 point drop in the DOW this week was a leak that has now been fully priced into the market, or we’re in for an even bigger drop on Monday.