Death by Credit Rating

On April 18^th, the U.S. Dow dropped 1.7% even while Standard & Poor’s credit rating maintained U.S. debt at its highest and best AAA rating, because of a little side note, stocks began tumbling: S&P “downgraded its credit outlook to negative from stable, citing a ‘material risk’ that policymakers won't be able to agree on a plan to deal with the ‘very large’ budget deficit.” DailyFinance.com, April 18^th. To most, this news is no news, but those worried about inflation and costs, it signaled a very real expectation that the United States would have to pay more interest on its deficit and that interest rates – from real estate to consumer debt to corporate borrowings – that are dollar denominated are about to rise. In short, this is another variable that will make us pay more and get less. The markets immediately began searching for an alternative to U.S. Treasuries, the currency of our deficit debt.

As risk rises, based on credit ratings, borrowers have to pay more. Those who are most desperate for loans and have the least to offer in the way of guarantees and assurances therefore pay the highest rates, even though they are the folks who have the least ability to pay the higher cost. Catch-22. If you don’t need money, your credit rating is apt to be high and your borrowing costs low. If you really need the cash, that alone drops your credit rating and delivers money at a significantly higher cost. Big U.S. companies can borrow at somewhere around prime; try doing that as an ordinary consumer! Look at the interest rate that goes with your credit card.

For those economies that suffer with horrific over-borrowings and humongous deficits with limited underlying resources to repay them, the future is bleak-minus-ten. Even for modern Western countries that are part of the European Union. I’ve blogged about Portugal recently, and Greece and Spain a while ago… the poor men of Europe, pejoratively referred to as the PIGS (an acronym for Portugal, Ireland, Greece and Spain). Taxpayers in richer EU countries are beginning to resent having to fork over cash to bailout what the locals see as irresponsible national borrowings of these PIGS.

It looks bad for each of these nations, begging for stabilizing loans, but Greece just got slammed the hardest as the credit rating agencies pretty much trashed their ratings through the floor: “Greek two- and 10-year government bonds slumped, driving yields to the highest since before the introduction of the euro, amid concern the nation won’t be able to avoid defaulting on its debt.

The Greek two-year note yield surged to 20 percent, the highest borrowing cost among developed nations. Portuguese two- and 10-year yields also reached euro-era records, even as Greek officials said restructuring isn’t being discussed. Finnish euro-skeptics won support in yesterday’s election as voters protested funding euro-region bailouts… ‘Risk is one of the main drivers, with the restructuring debate moving to the front pages again and the Finnish election results not doing anything to deter those feelings,’ said Christopher Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt.” Bloomberg.com, April 18^th. EU powerhouses are bailing out of bailing out.

The bottom line is that we do not control our own interest rates, since if we try and hold them below market expectations, folks stay away from taking that debt in droves. Then the Fed has to buy them with money it just… er… declares (increasing M1 money supply which some call “printing money’). That in turn triggers inflation in which the U.S. dollar is effectively devalued resulting in effectively the same economic correction whether we like it or not. On the other hand, if we impose the kind of austerity that national debt reduction truly requires, we can extrapolate from England’s recent experience with the same philosophy that consumer demand (the driver of any recovery) will drop, more folks will lose their jobs and real estate will sit at the lowest values in recent memory. Double dip anyone?

I’m Peter Dekom, and if anyone tries to tell you the clear and simple path towards economic recovery, the one sure thing you can figure out is that they really do not know remotely what they are talking about!