Transcript

The Idiot's Guide to the S&P Downgrade

THE IDIOT'S GUIDE TO SeP THE 08 DOWNGRADE On August 5th, Standard and Poor's downgraded the United State's sterling AAA rating to AA+. But what does this letter grade really mean for consumers and citizens? We have compiled a guide to help steer you through the ups and downs of sovereign credit ratings. | A- COUNTRIES HAVE CREDIT RATINGS? | A- Yes. Just like individuals, nations, banks, companies, and states have credits ratings assigned to them by third-party raters. And just like individuals, a nation's rating determines its credibility and the rate at which it can borrow money in the markets. The sovereign rating indicates the risk level of investing in that particular country. WHO ARE THE BIG THREE? WHAT IS THE S&P CREDIT RATING? Among the top credit rating agencies are Standard and Poor's, Moody's, and Fitch Ratings. These agencies give credit ratings to nations, companies, banks, etc. In 1860, Standard & Poor's earliest incarnation was born as a way for Henry Poor to provide investors with accurate information about corporations. The first credit ratings were published in 1916. PER CAPITA INCOME HOW IS A CREDIT RATING DETERMINED? ECONOMIC DEVELOPMENT Unlike a credit score, a credit rating represents a credit rating agency's evaluation of the qualitative and quantitative information for a company or government, including non-public information obtained by analysts. Here are some criteria that different credit rating agencies look at. It is believed that once a The greater the potential tax base for each country, the greater the ability of the government to repay debts. This also serves to measure country reaches a certain income or level of development it is less likely to default. A simple indicator comes from the International Monetary Fund (IMF) classification of an the level of political stability in the sovereign nation. industrialized nation. GDP GROWTH INFLATION AA FISCAL/EXTERNAL BALANCE EXTERNAL DEBT A high rate of economic growth suggests that a country's existing debt burden will become easier to payoff overtime. Countries that have a high rate of inflation are countries that may also have structural problems with the government's finances. This often reflects on A large federal deficit suggests a government is unable to service its debt. A The higher the debt burden, usually, the higher risk of default. The weight of the burden increases as a large external debt account indicates that public and private sectors rely too heavily on foreign funds. country's foreign currency debt rises relative to its a government's inability to cover expenses through taxes. foreign currency earnings. HIGHEST RATING MA Extremely strong capacity to meet financial commitments. WHAT DO THE RATINGS MEAN? UNDER OBSERVATION AA AA- Very strong capacity to meet financial commitments. Every rating company has its A- Strong capacity to meet financial commitments, but subject to adverse economic conditions. own method and rating UNITED KINGDOM SWEDEN systems. S&P and Fitch have very similar rating scales that run from AAA to CCC (CC in S&P's case). Moody's ratings BBB- Considered lowest investment grade by market UNITED STATES CHINA participants. SPECULATIVE BB BB- Highest speculative grade by market participants. run from Aaa to Ca. For all ISRAEL SOUTH KOREA three, AAA or Aaa is considered prime, and BB+ or B- Vulnerable to adverse conditions Bal is considered but has some capacity to meet IRELAND PORTUGAL non-investment grade. commitments. However, the credit agencies URUGUAY VIETNAM CCC- Vulnerable to favorable business-highly vulnerable. don't always agree and will NEGATIVE OR STABLE OUTLOOK? CC give different sovereign states & lower different credit ratings. Here ARGENTINA PAKISTAN we look at the spectrum of In addition to a graded rating, Payment Default ratings for S&P and some Standard and Poor's issues a negative or stable outlook for economies. Those with negative countries that fall under those rating categories. GREECE NO CURRENT COUNTRIES outlooks are under observation. HOW DID WE GET HERE? 2001 2008 Now that we understand some of the credit rating system basics, we must look at what made the US downgrade from 2001 2007 AAA status to AA+. While the US deficit has been increasing since the 1970s the most recent turn of events has caused insecurity in the economy. CBO projects the US is on track to pay off the entire national debt Housing bubble bursts with widespread foreclosures and defaults. Almost $5 trillion is added to the public debt due to wars, tax cuts, within a decade. TARP, and stimulus. NOV 2010 OCT 2010 DEC 2007 2009 2008 Republicans win US House majority, conflicts between Congress and US enters a recession. US economy continues Recession is S&P endorses the considered "over." nation's AAA rating with to decline. stable outlook. administration. MAR 2011 APR 2011 JUL 2011 AUG 2011 S&P downgrades US debt citing Congress's refusal to consider new Debt ceiling debate begins. S&P changes the US outlook from stable to Congressional bickering and debt ceiling standoff are pushed to the last day. revenue. negative. WHAT WILL THE DOWNGRADE AFFECT? Both stock and bond investments are expected to experience a period of volatility with the downgrade to AA+. While many feared there would be a massive sell-off of Treasury bonds the opposite happened when the markets opened. Stock prices fell and bond prices rose. STOCK & BOND PRICES Government-related enterprises are any entities that are practically or totally controlled by the government. GRE's ratings usually fall between their stand-alone status and their sovereign status. With the S&P downgrade of enterprises such as Fannie Mae and Freddie Mac, Air Exchange Service, Navy Exchange Command, US banks, insurers will also see their AAA rating lowered to AA+. GOVERNMENT-RELATED ENTERPRISES Mortgages, such as fixed-rate mortgages, generally track the 10-year Treasury note. This note's interest rates are expected to rise with the downgrade. Interest rates on fixed-rate mortgages are not expected to rise more than half a percent. Credit cards are also pegged into the prime rate, but any rise in interest in this area will likely be the result of broader economic conditions. HOME LOANS & CREDIT CARDS Most student loans are connected to the London Interbank Offered Rate (LIBOR) which is influenced by Treasury yields. If yield on security rises due to the downgrade then student loan rates will most likely rise as wellI. New loans will probably see the greatest increase in costs due to the activity in the securities market. STUDENT LOANS SOURCES: NYTIMES I STANDARDANDPOORS I GUARDIAN.CO.UK I BUSINESSINSIDER.COMI MONEY.CNN.COM I NPR.ORG VISIBLE

The Idiot's Guide to the S&P Downgrade

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On August 5th, Standard and Poor’s downgraded the United State’s sterling AAA rating to AA+. But what does this letter grade really mean for consumers and citizens? We have compiled a guide to hel...

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