A True Or False Take On The US

Let's play a little game of True or False about Wall Street A.D. (After Downgrade) lest the Hoople Heads/"experts" on TV or in your office twist your head around just when you need it most...

We have a Debt Crisis: False

We don't have a Debt Crisis, we have a Dickhead Crisis - meaning there are way too many of them running around Washington not doing what they're supposed to do.  S&P admitted that both the timing of their downgrade and its rationale were based on political disharmony and not the question of whether or not the US could actually make good.

S&P has no credibility anyway:  True

As Paul Krugman reminds us in his piece on chutzpah this morning, S&P was one of the prime contributors to the credit bubble that got the US into this position in the first place, it was also rating Lehman Brothers bonds as "A" up until the day Lehman filed for bankruptcy.

The Downgrade to AA+ will force institutions to dump Treasurys:  False

Virtually no one running institutional money will be selling treasurys as a result of S&P.  They are owned as a highly-liquid instrument and the downgrade does not affect that feature.

The downgrade is the first of many:  False

Moodys has just reiterated that they will not be downgrading the US at this point, they reaffirmed their triple A rating on August 2nd and had this to say :  "We expect the economic recovery will continue and additional budget deficit reduction initiatives will be put in place by 2013.  The political parties now appear to share similar deficit reduction objectives."  The ratings agency does have the US on credit watch negative but will probably not act so long as the US makes payments and comes to an agreement on deficit reduction this fall.

Borrowing costs will shoot up for the US government and its related entities:  False

S&P is just another opinion, albeit a widely-heralded one.  In the long run, the market forms its own opinion and acts accordingly.  My friend Vitaliy Katsenelson reminds us that "Japanese debt was downgraded to AA- in January 2011.  It was a nonevent.  Despite being the most indebted developed nation, Japan is still borrowing at the same pre-downgrade rates, which are half of the rates the US government pays on its debt.  On the other hand, Italy’s 10-year bond rates jumped to 6% in August without any downgrade by credit agencies: the markets did their own credit analysis."

Europe was the real story behind the market's drop last week:  False

I'd love to pin the 13% (and counting) drop on the Euro Mess - it would mean that we have an easier way out of it.  But to do so would be to ignore the higher likelihood of a US recession that virtually ever single data point brings with it.  Last week's manufacturing and jobs numbers were a huge contributor to the selling, no matter what the perma-bulls say about Europe.

The big concern is not Treasurys but sentiment and the borrowing costs of other entities:  True

In a classic case of market perversity, it is very possible to see even more money come into the Treasury market as a result of the downgrade as the sales of other risk assets (high yield bonds, commodities and stocks) mean ever more capital plowed into money market funds at brokerages and banks.  The real worry going forward is about what ratings agencies and market participants do the cost of borrowing for issuers who are sub-Treaury.  Moodys told us in July that lower ratings on Treasurys could lead to downgrades on 7000 municipal bonds worth $130 billion dollars.  In terms of sentiment, the stock market will doubtlessly be very whippy in the coming days and weeks.  All types of reactions (ranging from relief to despondency) are on the table, but I would guess that outflows will continue on a net basis.