Late Friday afternoon, August 5, 2011, when most people were off to Happy Hour, drowning their cares after a wild week of Dow Drops, Standard and Poor's dropped a bomb. The U.S. Credit Rating was downgraded from AAA to AA+. The U.S. is no longer on CreditWatch, but the Outlook is Negative, meaning that if Congress does not make the requested budget savings of at least $4 trillion as soon as possible, the U.S. credit rating could be downgraded again.
Below are FAQS and answers on the downgrade. Additionally, you'll find links to the White House, the House of Representatives and the Senate below, so that you can email your elected officials and encourage (demand) that they stop the politics and get America's fiscal house in order. Armed with the FAQs, you will be in a position to understand clearly that both sides of the aisle failed the American people.
1. What are "budget savings?"
The credit rating agencies take "no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.'s finances on a sustainable footing," according to both Moody's and Standard & Poor's. However, both agencies have been clear that the key to avoiding the downgrade was to implement $4 trillion in savings over the next ten years, which could be achieved from a mix of cuts and increased revenue -- provided the cuts and taxes/revenue would not damage GDP growth. I wrote extensively on this topic on July 27, 2011, in my article, "Debt Downgrade and Default: Uncovering the Bipartisan Truth." Read this article at HuffingtonPost.com/Natalie-Pace.
2. What happens now?
If Congress gets smart, goes back into negotiations immediately and comes up with a credible plan to implement budget savings of more than $4 trillion over the next 10 years, the world will have renewed faith in the world's largest economy. If they don't, GDP growth will slow, unemployment will remain high, interest rates will rise and companies that are linked closely to the U.S. government will also be downgraded, namely Fannie Mae, Freddie Mac, the 'AAA' rated Federal Home Loan Banks, and the 'AAA' rated Federal Farm Credit System Banks, the Army & Air Force Exchange Service, the Marine Corps Community Services, and the Navy Exchange Service Command. The stock market has already retreated, and the bond market could also retreat, further decimating the individual retirement plans of hundreds of millions of Americans, which have not fully recovered from the losses in the Great Recession.
3. Interest Rates.
The U.S. will now have to pay higher interest rates on its debt. That means that the Debt Ceiling Deal is now a joke. Achieving $4 trillion in budget savings will require even more spending cuts and revenue generating (taxes). Interest will become an even bigger slice of the spending in Washington, making it even more difficult to balance the budget.
4. Stock Market.
The S&P500 Index dropped 4.8% on August 4, 2011 (savvy investors were already anticipating the downgrade) and is down 12% since the high of April 29, 2011. Since the downgrade occurred after markets closed on Friday, there could be another slump when markets open on Monday, August 8, 2011. However, that does not necessarily predict a bear market. While the downgrade is bad news and the ramifications of the downgrade will be felt broadly and deeply in the months to come, that does not mean that selling your stocks on Monday is the best idea. (Keep reading this article to the end before you make your decisions.) If you bought into the NASDAQ when the markets opened after 9.11.01, your returns were, on average, 35% gains within four short months (by January 2002). If you sold, you locked in losses and sold low, when you could have made a much more profitable choice within a few short months.
The downgrade of the U.S. credit rating is sad and shocking, but it is a message to Washington to get America's fiscal house in order, not a death knell for the U.S. As Dr. Lawrence Yun, the chief economist at the National Association of Realtors reminds us, "Many big companies have huge cash reserves at this moment so the corporate [bond] rates may not move too much on the news." In fact, if the dollar weakens, exports could actually benefit. Many U.S. corporations are getting a significant portion of their revenue from other countries. So, 3rd quarter earnings could be better than you might expect, even if growth is dampened by the downgrade.
5. Bond Market.
The downgrade will be felt in the bond market -- particularly in Treasury bills. Rising interest rates (as a result of credit downgrades) decrease the value of existing bonds. The prices for financing a home will go up (unless the Feds print a lot more money). Dr. Yun is not worried that higher interest rates will weigh down the housing market. He's more concerned about underwriting standards, which in his view are "way too tight." A senior executive of a major investment bank in New York City told me that corporate bonds will be affected, but he doesn't anticipate a crash because bondholders are less emotional than stock owners.
The Federal Open Market Committee meets on Tuesday, August 9, 2011, and their response may be to print more money and buy it up themselves (Quantitative Easing III?). In that case, the excess cash in the system means inflation. Low risk, cash positive hard assets become desirable in that scenario.
The bottom line is that you need to check your bond portfolio with a forensic eye to credit risk, as well as inflation risk. There are two important articles on this topic in my May 2011 NataliePace.com ezine, volume 8, issue 5. Bonds are no longer safe across the board, and they can definitely lose principal value in today's world. (I began issuing bond alerts in 2009.)
6. Should You Sell Into a Slide?
Be very careful. You might think that getting your order in now will mean you are first in line, but executing a market order into a falling marketplace can be a disaster. If you are determined to sell on Monday, then consider placing a limit order, where you get to determine your sell price. It was a far more profitable idea to sell a few months after 9.11, than it was to try and stop losses when the markets opened on the 17th of September, 2011.
The savvy investor has a Stock Shopping List handy for market corrections like this. And that person is always in the best seat to buy low, instead of selling low, when the markets slide.
7. Will the Markets Fall to Zero?
No. Even if investors wanted to take the stock market to zero, they can't. There are mechanisms that halt trading if the markets fall too far, too fast. There are three circuit breaker thresholds -- 10%, 20%, and 30%. If there is a 10% (1200-point) drop in the Dow Jones Industrial Average before 2:00 p.m. ET, the market will stop trading for one-hour. If there is a 20% drop (2400-points) before 1:00 p.m., the market will stop for two hours. In the event of a 30% drop, regardless of the time, the market closes for the day. After 9.11, the stock market was closed all week, reopening on the following Monday, September 17, 2001.
Under a new pilot framework established by the SEC, FINRA and the stock exchanges, there is a 5-minute "pause" that is triggered when certain individual stocks fall by more than 10% in a 5-minute period.
8. How long will stocks take to recover?
The long-term recovery is highly correlated with GDP growth. If the U.S. economy starts growing again, stocks will rise. Before this debacle, the economy was predicted to have a relatively strong second half in terms of GDP growth, continuing into 2012 -- a positive sign. If consumers are disgusted with Congress and worried about the economy, they may stop spending, which impacts corporate sales and profitability, which slows GDP growth. This will be an ongoing story, which I will continue to report on in my Hot News on Cool Stocks reports, twice a month.
9. What should you do?
Contact your Congressman and the White House and demand that they come up with a bipartisan plan to implement more than $4 trillion in budget savings over the next 10-years, so that the U.S. can earn back its AAA rating and get back to the business of growing the economy and creating jobs. The politics must stop. Paying our bills, creating a sustainable plan for spending (including Medicare, Medical, Social Security and Defense -- the Big Four) and reforming the tax code is a bipartisan approach that is recommended by the most respected economists in the world.
http://house.gov/
http://senate.gov/
http://www.whitehouse.gov/
10. Who's to blame?
According to Neil Cavuto (speaking on Cavuto on Business August 6, 2011), Senator Mitch McConnell said that he could have reached the $4 trillion mark if the Republicans had agreed to raise taxes, which he refused to do. There are widespread reports that the Obama Administration had agreed to support an increase in Medicare's eligibility age, to means-test certain Medicare programs, to cut Medicaid benefits and to restructure the payments of Social Security benefits as part of a grand bargain with Republicans, if there was also a plan to increase revenue. Majority Senate Leader Harry Reid bragged that the new Debt Ceiling Deal would not be making any cuts to the entitlement programs. Both parties congratulated themselves on the Debt Ceiling Deal and tried to promote the idea that the deal had "averted fiscal calamity," when in fact it had missed the $4 trillion in budget savings by almost $2 trillion. As we saw with the market drop on Thursday, Americans weren't buying that. As we saw on Friday with the Standard and Poor's downgrade, neither did the credit rating agencies.
I have a very important call-in radio show on Wednesday, August 10, 2011 at 9:00 a.m. PT (noon ET). I will provide another market update at that time, and you will also have the opportunity to get your questions answered. Call into: (347) 215-7305. Log onto: BlogTalkRadio.com/NataliePace.
About Natalie Pace:
Natalie Pace is the author of You Vs. Wall Street and the founder and CEO of the Women's Investment Network, LLC. She is a blogger on HuffingtonPost.com and a repeat guest on national television and radio shows such as Good Morning America, Fox News, CNBC, ABC-TV, Forbes.com, NPR and more. As a philanthropist, she has helped to raise more than two million for Los Angeles public schools and financial literacy. Follow her on Facebook.com/NWPace. For more information please visit NataliePace.com.
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You can access a full report from Standard and Poor's on the downgrade on the home page at StandardandPoors.com. Do not rely upon a paragraph or sentence here or there pulled out and quoted for you. Each party could do that and make it appear that the downgrade was the other party's fault. And the truth is that the $4 trillion in budget savings over 10 years required a bipartisan approach. Both parties were wrong, and both missed the mark by almost $2 trillion. Also, don't rely on people quoting Tim Geithner (or even Tim Geithner quoting himself) that S&P got the math wrong. Here's a link to Tim's Op-Ed in the WashingtonPost the day the deal was announced. In "Compromise Achieved, Reform’s the Next Chapter," Treasury Secretary Geithner said that the deal offered $2 trillion in budget savings (not the $4 trillion that everyone knew was necessary to maintain a AAA rating).
The President, the Treasury Secretary and the Congressional leaders all knew that $4 trillion was needed. So, why did they come up with only $2 trillion?
http://www.standardandpoors.com/home/en/us
http://www.treasury.gov/press-center/press-releases/Pages/tg1264.aspx
http://www.treasury.gov/press-center/press-releases/Pages/tg1264.aspx
"It appears that for now, new revenues have dropped down on the menu of policy options. […]
The act contains no measures to raise taxes or otherwise enhance revenues, though the committee could recommend them. […]Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act."
Even though S&P's credibility should be questioned, at least they mentioned that. Why didn't you?
http://www.huffingtonpost.com/natalie-pace/debt-downgrade-and-defaul_b_911669.html
This article was published after the downgrade, but before the markets opened, for investors -- to help them to anticipate the volatile trading week that we were about to enter... The first article was to educate Americans on what was needed to avoid the downgrade. This article on what was needed to protect yourself, now that the downgrade was allowed by politicians to happen.
However, I have to disagree with your last sentence. Only one of the 3 major rating agencies downgraded the US. And, what adds more insult to injury is that that the same agency that downgraded us gave Triple AAA ratings to subprime investments that lead to our current crisis.
So, in all fairness, who's to say that politicians allowed this to happen?
Where are our leaders to defend our money ratios from these predators? Well, the Republicans they surrendered. John McCain says don't shoot the messenger. He is happy to surrender to predators because they make it easy for him to cut the safety net! Yep. The Republicans have spent decades now ignoring the cost of health and demonizing those that try to lead, and now they want to gut the safety nets to pay for their bad fiscal policy! He voted against the tax cuts a big part of fiscal abuse. He runs the barriers and walls of discretionary military spending, and he is one wealthy guy. John McCain surrendered our money ratios to the shoddy S&P to protect his bad fiscal policy!
https://www.cia.gov/library/publications/the-world-factbook/geos/us.html
Austerity ( spending cuts and tax increases ) will lower promote GDP growth and lower unemployment! Someone should tell Europe! After several countries there implemented austerity there they seem under the delusion that it was a downer to their economies.
In the long term our debt levels and deficit are truly unsustainable. Some level of austerity is needed. But let's not kid outselves. austerity ( particularly if badly done ) will weaken the US economy and slow our recovery. Anyone who claims otherwise despite all the evidence and examples to the contrary has not been paying attention.
"The components of a solution to this crisis are clear. One major needed reform is a significant slowdown in the long-term growth of entitlements, especially Medicare and Medicaid, because entitlement growth is the main component of the long-term spending problem. A resolution of the long-term crisis also requires tax reforms that would broaden the tax base by reducing various subsidies and exemptions from the base, but would also lower marginal tax rates on most corporations and households. A broader and much flatter tax structure would raise taxes on some families and businesses, but it would bring in more revenue while causing much less harm to the economy," Dr. Gary Becker, Nobel Prize winning economist and University of Chicago professor.
And of course, your achilles-kneel is Social Security. See, I keep telling people on the left that SSN is a red flag for the conservatives. It's actually their main philosophical thrust. They've been gunning for it since it began. And this is why they hate this debt ceiling deal. Ha!
2) The flatter tax structure has often been mentioned by many economists and dissed by many others. But let's be honest what it does instead of using the general term "some". It lowers taxes for big business and well to do families. It raises taxes on the middle class, poor, and struggling small businesses. It's a gut punch to consumer demand and can drive the most vulnerable families into poverty. It's also electoral poison. Taxing poor or middle-class Republicans is the numero uno way to turn them into Democrats.
Look at today: gold and T-Bill prices are both up, which makes absolutely no sense. Gold prices rise because people fear inflation, devaluing of the dollar. But in that case US Treasuries should also lose value - and they did not.
No one understand the global economy. It's a "chaotic system" as we math types say.
Also, we call it borrowing but it is not borrowing in the sense that you think of it. Since we are not on a gold standard it is simply a measure of net money created. There is nothing to pay back as I stated above. It is simply a representation of net new money.
We are one of the last holdouts that still use this gold standard archaic leftover from a system we no longer even use. What we now use the treasury market for is just as an interest rate maintenance account. We should simply modernize our system the way everyone else does and simply control interest rates through the reserve accounts.