Common Sense Comes to Town!

Common sense is the most fairly distributed thing in the world, for each one thinks he is so well-endowed with it that even those who are hardest to satisfy in all other matters are not in the habit of desiring more of it than they already have. (Descartes)

It’s the Economy, Stupid!

Posted on | August 6, 2011 | No Comments

Much has been said about this historical downgrade inflicted to the USA this week by Standard and Poor’s. The rating agency indeed brought its appraisal of American debt from AAA, the highest possible rating, to AA+, on notch below. Let’s take a moment to breathe in deeply and look at this entire situation with a different perspective.

First of all what is Standard and Poor’s? It is one of the companies which contributed to the economic recession of 2007 by granting AAA ratings to some types of asset-backed securities. Many questions were later raised about its business model’s ethic given that financial firms had to pay in order to get their publicly offered products rated. You can learn more on this topic in Charles Ferguson’s excellent documentary Inside Job, which won an Oscar this winter.

You are not reassured? Neither am I! In fact if S&P is playing the toxic-asset game again, you can probably wager safely that the American debt no longer has any worth whatsoever. So what and who are those ratings for? They are used by many institutional investors (pension funds, cities, governments, large charities, etc.) who often have strict investment guidelines to follow. Since it is easier to follow someone else’s opinion than to come up with a clear picture ourselves through careful study, they don’t hesitate to invest their money – actually, your money – in securities that they don’t really understand.

Still, why worry? The asset-backed paper downgrade was brought about by securities linked to about 1.3 trillion dollars worth of subprime mortgages. The loss of the Western financial sector reached about 2.8 trillion; this doesn’t mention collateral damage such as the loss in wealth in residential values (over 4 trillion dollars in the US alone).

1.3 trillion is a lot of money, but it is dwarfed by the size of the American debt, which reaches over 14 trillion. Various investors who depended on American treasury bonds to balance their portfolio will now have to revise their placement strategy. If the downgrade is maintained, no one on the market will want to buy this product. The imbalance between supply and demand will drive the price, and the value of investors’ portfolio, down. In the end it is you and me who will suffer the nastier effect given that our governments, retirement funds and others have tied themselves to the American debt.

So you see there is no reason to worry: it is probably too late to do something anyway!


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