George Maniere: Financial Markets Finally Begin Taking a Downgrade Seriously

InvestingAdvicebyGeorge – We are finally on the brink and the financial markets are finally beginning to take a serious look at the prospect of a downgrade of the U.S.  AAA credit rating, which it has held for nearly a century, very seriously.  As Republicans and Democrats continue to move further apart on their plans to reduce the nation’s deficit and its borrowing limit the realization of what a catastrophic event this would be is finally beginning to sink in.

In a prime time televised speech, President Obama warned the nation that with no clear resolution insight the government is on the brink of a credit down grade that would deeply damage the economy and send a global ripple effect through the world markets. For the first time in our nation’s history the AAA credit rating could be downgraded, leaving global investors to wonder whether the United States can meet its financial obligations.

Republican House Speaker John Boehner responded to the president’s speech by asserting that his plan would avoid a downgrade and characterizing the president’s plan as a “we spend more, you pay more” philosophy.

Meanwhile House Speaker Boehner and Senate Majority Leader Harry Reid both launched separate plans that would stave off the possibility of a downgrade. Oddly, Senator Reid’s proposal, which would include no additional tax revenue, was endorsed by President Obama. This is a striking contradiction to his assertion that any plan must include added tax revenues. The president in his address to the nation never mentioned this.

Despite all of the last minute maneuvering the markets seem to believe that Washington will find some way to reach an agreement that will allow the government to keep paying its debts. There are those, however, that believe that it may not be enough to avoid a downgrade of our credit rating. Indeed, several unnamed sources were cited as saying that S&P has said that a $4 trillion debt reduction would be needed for the U.S to keep its AAA rating and neither side is even remotely close to that figure.

The possible downgrade from AAA caries serious implications because there are many pension and mutual funds that are prohibited from investing in anything that is not AAA grade.

According to an article in Tuesdays Wall Street Journal, J.P. Morgan said that the possibility of a downgrade would raise the treasury rates by 70 basis points in the long term or in terms of dollars; that’s a permanent increase in U.S. borrowing costs of $100 billion a year. While the credit rating does not determine interest rates, I can only conclude that the psychological effect it would have on foreign Treasury buyers would be significant. 

Yesterday, President Obama was reported to have said that he would veto anything that House Speaker John Boehner put in front of him.  I must conclude that he was misquoted. With the credit rating of the U.S. Government hanging is the balance I find it unbelievable that he would have the arrogance to say such a thing. Be that as it may, whether he was misquoted of not as soon as the reports hit the wires the market turned around and closed down 91 points on the DOW and 5.5 points on the S&P.

In conclusion, if a resolution is not reached by August 2nd all three credit agencies will likely make good on their threat to downgrade our credit rating, which I assume will be from the current “AAA” rating to “AA”.  While I see a massive selloff of our Treasuries as very unlikely, I do believe that a downgrade would force money market funds and other institutional holders would have no option but to sell because they work within strict parameters that mandate that they hold only AAA rated instruments. Sadly I also see interest rates moving higher which would further weaken our already fragile economy. While the market would sell off, the big winners in this scenario would be gold and silver. Also, as the market sells off my readers who have properly positioned themselves in precious metals and cash would have the opportunity to buy into safe haven stocks at a once in a lifetime price.

About The Author – George has been an investor for 30+ years. When he retired in 2004, he took over the control of his investments full time. In March of 2009 he committed a sizable stake to the market and doubled his money. he sold half about a year ago and what he started with is in drips dividend reinvesting. The other half he have been a bit more speculative with, but he recently bought SLV at $26.00 in January and sold it all on April 29th for a 66% realized gain. He spends my time reading every financial classic he can get his hands on and has become a fairly good chartist


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