The Weekly CryGest

4 Most Depressing Consequences of the Sovereign Debt Rating Downgrade

2011-08-14T04:19:00.001+05:30

1) Washington plays the blame game

After the downgrade announcement by Standard & Poor's, politicians in Washington almost immediately put their PR activities in overdrive with what seemed like the sole motive of trying to pin the blame on someone.

The Republicans blamed Obama, the Democrats blamed the Republicans, everybody blamed S&P, and nobody really took the time out to accept that there was a real problem. S&P had even made it clear that one of the major reasons for the debt downgrade was that the irresponsible manner in which the debt ceiling debate was handled indicated that the political system was far from efficient in a time when the U.S. needs a strong political system.

Given that the U.S. Treasury came within a couple of days of defaulting on interest payments for its $14 Trillion debts outstanding, a situation brought upon by partisan bickering in Washington, and that a half baked bill was basically just handed in at the last minute to stave off a near term default without any solutions for reducing the budget deficit, and that even after a downgrade, the political system did not attempt to at least discuss options for reducing the deficit, but blamed the agency that cut its rating for making a mistake, it seems to us that S&P had plenty strong reason to at least state that the political system in the U.S. has become too unstable for a sustainable economy.

2) Otherwise Sane People Making Inane Comments

This has played out in a number of ways. There was the instance where President Obama stated that the U.S. "would always be a AAA nation." There was Warren Buffet, an otherwise very savvy investor and the largest shareholder of Moody's, the second biggest rating agency, claiming that the U.S. deserved a Quadruple A rating. You can find more examples by watching any 5 minute clip from CNBC's programming last week.

It is surprising that the same people who trust the rating agencies, who rely on the analysis performed by the ratings agencies, and in Buffet's case, who own the rating agencies, are basically trying to say that the recent downgrade does not apply.

The rating agencies exist to attempt to provide an estimation of the riskiness of investments. By attempting to write off the downgrade, what these otherwise sane people are doing is attempting to express their anger/frustration/etc. in a non-constructive manner.

It's pretty much equivalent to a bank denying you a loan by saying that you're not creditworthy and you storming out while screaming that one day you will buy the bank. It looks stupid and insane.

3) An Asset Bubble is Growing in Treasuries - Yes, the same thing that got downgraded

Speaking of stupid and insane, there seemed to be two assets that really jumped last week. One was Gold, and the other was Treasury bonds!

Alright, we understand that both Gold and Treasuries are taken to be safe haven assets. And yes, we understand that a downgrade of the U.S. Sovereign Debt rating is likely to cause global market turmoil (which it did).

But for crying out loud, who buys an asset at a higher price when it has just been announced that the asset had become more risky than before? And this practice of buying Treasuries was so widespread last week that the 10 year bond auctioned during the week sold at historic low yields (high prices).

Sure, the Federal Reserve announced that interest rates will be kept low until 2013, but the rates weren't changed. Sure, the yield curve may flatten a little bit, but only if there is not pricing in of the additional risk.

Unfortunately, it seems that the riskier nature of Treasuries is not being reflected in their prices and if this bubble is to pop, the consequences for the global economy may be close to catastrophic.

4) Currently used Financial Models can't handle a U.S. downgrade

Pretty much at the core of all the financial valuation models currently used is that underlying assumption that U.S. government debt is risk free. The risk of other assets are computed by adding the risk premium to the yields of risk free Treasuries.

Now if Treasuries are no longer risk free, these models cannot be used to accurately quantify the value of any financial asset. Sure, we could just use the Treasury yield as per market and allow the risk premium figure to be negative in case we are valuing a AAA rated asset.

However, there is no available data to compute negative risk premiums and no telling whether that model would work.

We are sure that the geniuses on Wall Street would come up with something to approximate the value of securities taking into account the added risk in Treasuries. When (s)he does, every bank, every pension fund, every insurance company, and many large companies and high net worth individuals would have to revalue their net worth. And there's no telling if there's going to be another AIG or Lehman as a result

Speculative Update: Bank of America looking very jittery

2011-08-09T15:57:00.000+05:30

* Please note that this post is speculative only. The Weekly CryGest is not responsible for anything that results due to this (or any other, to be honest) post.

Bank of America Corp. (BAC) fell over 20% in yesterday's trading. We don't mean to predict anything here at The Weekly CryGest, but we think there could be a significant problem arising at the bank mainly due to record claims from Fannie and Freddie over soured mortgage loans.

Exacerbating the problem is that Freddie Mac has already asked the government for $1.5 Billion and with government finances the way they are, it is very possible that Freddie and Fannie would be 'urged' to organize as much of its funding requirements from the private sector.

Again, we're not saying something will happen, but, we think something might be brewing at Bank of America. And if something happens, remember Lehman?

U.S. Debt Ratings Cut, S&P Blamed

2011-08-08T01:34:00.002+05:30

Standard & Poor's cut the long term sovereign debt rating on U.S. Government Bonds on Friday in an unprecedented, though not unexpected move.

Among the reasons cited for the ratings cut were “that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in (S&P's) view, would be necessary to stabilize the government’s medium-term debt dynamics,” and excessive political "brinksmanship" demonstrated during the Debt Ceiling debates.

It seems that S&P was a little displeased that lawmakers in Washington could allow the U.S. government to come so close to a catastrophic default in their quest to stop the opposing party from getting their way. Lawmakers from both parties hit back at Standard & Poor's accusing them of having a primitive and unsophisticated understanding of the U.S. economy and citing that the agency had displayed a poor track record during the housing crisis.

It is true that S&P had made horrid calls in the run up to and during the housing crisis. It displayed massive incompetence at assessing the risk inherent in mortgage backed securities, wherein it valued some securities, especially those with backing from organizations such as Fannie Mae and Freddie Mac. However, the problem then was the rating cuts were too late and too little given what events had occurred.

Some would argue that letting a AAA rated nation's debt levels reach $14.6 Trillion, after not once, but twice raising revenues from its own Central Bank (read quantitative easing), while simultaneously initiating further government spending plans with no plans on generating government revenues in the medium term, before cutting the nation's rating to AA+ is, on the part of the rating agencies, factors that prove that ratings cuts are still doing too little too late.

At least the banker to the U.S. seemed to think so. China, through its state owned news agency issued a statement criticizing the U.S. of making some very poor fiscal choices and managing the debt ceiling issue in a very poor manner. The statement went on to express severe concern about the safety of China's holdings of U.S. debt - amounting to over US $1 Trillion.

They went on to offer some suggestions to improve the issue and to avert a situation of this nature occurring again in the future. Their first suggested solution was for the U.S. to cut spending in areas such as defence and social services. If we look past the irony that China, a communist nation with the world's largest army, is lecturing another nation on overspending on social services and defence, we have to face the facts that with two pocket-bleeding wars going on and a population that tends towards the aged end of the spectrum, any cuts to spending in those areas would mean significant pain for the U.S. and the American people.

In order to avoid a "who are they to tell us what to do" attack by certain (probably Republican) politicians, the Chinese government statement went on to offer a second suggestion: to remove the prominence of the U.S. dollar in the global economy by creating a new global trade currency or basket of currencies. This move might seem to be difficult to accomplish without global support but China seems intent on establishing itself as the new big swinging dick on the block, and can simply decide to reduce its future purchases of U.S. treasuries.

The consequences of either reducing the liquidity of the market for U.S. treasury bonds or replacing the Dollar as the sole global trade currency would have catastrophic effects on the welfare of the U.S. and the American people by reducing the economic power and supremacy the nation previously enjoyed.

It seems that it would be less painful for the nation to just swallow the bitter pill and deal with the consequences of cutting spending and raising revenues, than being replaced as the economic superpower. Actually, even if revenues are raised and costs are cut, the U.S. might be on its way to losing its sole superpower status.

China certainly thinks so. And currently, that might be what matters most.

Update: Debt Debacle - Talks go backwards as potential U.S. Sovereign Default deadline looms

2011-07-30T18:23:00.002+05:30

Last week, we wrote about the standoff between House Republicans and the President in coming to a resolution to the debt ceiling issue. Well, turns out, almost one week on and not only has there been little to no progress on the issue, but it seems like the discussions have taken a step back from resolution.

While the bigger stories last week rested on the hopelessly unproductive debate between House Speaker John Boehner and Barack Obama, the main story of this week is that of Boehner trying to chalk out a plan that can get the support of fellow Republicans. Seriously Mr. Boehner, one week you're trying to negotiate a solution to to the debt crisis with the President and the next, trying to figure out what your (and your party's) stance on the issue is?

Happily, the great negotiator John Boehner managed to get the support of his party on a revised version of the bill yesterday, filling the American people with hope that the issue will be resolved. Or at least, it might have done if the Senate had already stated plans to shelve it and the President already stated that he would veto the bill should it pass through the Senate. What was the point in even voting on that bill?

It is startling how a political system can be so depressingly inefficient that it allows someone to waste everyone's time just to prove that he has the support of his own party. And seriously Mr. Boehner, how unpopular must you have to be (or how ludicrously blockheaded must the members of your party have to be) for you to even fail at proving that easily.

In another startling step back, President Obama addressed the nation in all seriousness and requested that the American people "make themselves heard". Seriously, Mr Obama? You are, in all seriousness, with a completely straight face, requesting that a group of people, most of whom cannot find Russia on a map, inflict their opinions on a matter of great economic significance and complexity to the government? A government that even with the backing of brilliant economic advisers is going backwards when it comes to averting a sovereign default of their nation.

In another hilariously depressing and ironic newsbite, China's government finally got the opportunity to turn the tables on the U.S., calling it "dangerously irresponsible" the same week a train derailed near the Chinese city of Wenzhou killing 39 people.

Obama, Republicans keep playing Chicken with U.S. Economy as August 2nd approaches

2011-07-25T00:56:00.002+05:30

House Republicans ended discussions on raising the debt ceiling on U.S. government debt in a move that could very soon land the nation in a pretty sticky situation contemplating how to put a spin on defaulting on its sovereign debt.

The debt ceiling is a cap enforced by the Congress to keep a check on Congressional borrowing (and spending) in the same manner a degenerate gambler sets a maximum loss limit for his trip to the poker table. In keeping with the analogy, Congress has the power to arbitrarily increase the debt ceiling when it feels that it should borrow more to stay in the game and ride past its dry spell.

The Obama administration last increased the self enforced cap to 14.3 trillion dollars in February 2010 and had been fiscally responsible enough to ensure that they could ride through for over a year on the increase. However, the losing streak finally caught up with the administration and despite their best efforts (such as implementing policies that increased spending and barely increased tax revenues) found themselves staring at a realistically depressing situation of contemplating defaulting on its interest obligations for its existing debt by August 2nd.

In a bid to avert the situation, the administration, along with House and Senate Democrats, suggested borrowing more to pay for the interest obligations (that met with a collective "Oh shit, why didn't we think of that?" response by the multitude of the nation's former homeowners).

House Republicans however, have had other ideas. In a move that was certainly entirely based on concern over the fiscal responsibility of the nation and in no way influenced by the fact that it makes the President look like a powerless wimp with no control over the Country and the Economy, House Republicans strongly opposed the plans with House Speaker John Boehner ending negotiations on raising the debt ceiling earlier this week.

With the debt standoff as it stands, come August 2nd, the U.S. would have to face some serious problems in offering excuses when the Repo men arrive. Thankfully for the nation, they do not have much in terms of assets other than a powerful (albeit sure to be unstable) currency, a ravenous (though bankrupt and heavily indebted) consumer, and possibly most importantly the power of being able to devalue its debts further by having the Federal Reserve "fund" the nation's obligations through a smartly named acronym that in no way amounts to printing money to meet sovereign obligations.

Update: http://weeklycrygest.blogspot.com/2011/07/update-debt-debacle-talks-go-backwards.html

Welcome to The Weekly CryGest

2011-07-18T00:34:00.001+05:30

Hello All.

Welcome to The Weekly Crygest. In the coming weeks, this blog will target selected news and current affairs events every week and post a biased, opinionated, and sometimes factually incorrect view on each matter.

We would like to state upfront that we are not responsible for any harm, whether emotional, psychological, or of any other nature, caused by anything you read on this blog (although we would gladly take credit for any fortuitous event occurring in your life after reading it).

We hope that you enjoy the articles to come and would especially value your comments and feedback on the articles to come.

Ed.