It’s Monday, Aug 9. The stock markets are declining significantly, although anybody who says it’s panic doesn’t remember 2008. Anyway, lots of market commentators, you know the types on cable TV news networks, are all claiming the decline is due to the S&P downgrade. They’re wrong. Completely wrong as I pointed out already. But just to reinforce my point, here’s Paul Krugman just minutes ago:
Carnage in stock markets as I write — and all of the headlines I see attribute it to S&P’s downgrade.
They really are trying to make my head explode, aren’t they?
Once again: S&P declared that US debt is no longer a safe investment; yet investors are piling into US debt, not out of it, driving the 10-year interest ratebelow 2.4%. This amounts to a massive market rejection of S&P’s concerns.
The “signature” of debt concerns should be stock and bond prices both falling; what we actually see is those prices moving in opposite directions. And that’s normally the signature of concerns about a weak economy and deflation risk (see Japan, decline of).
What triggered economy fears? To some extent I think this is a Wile E. Coyote moment, with investors suddenly noticing just how weak the fundamentals are. Also, the mess in Europe.
And maybe, maybe there is an S&P story — but not the one you think. Arguably, that downgrade will bully policy makers into even more deflationary, contractionary policies than they would have undertaken otherwise, which has the perverse effect of making US debt more attractive, since the alternatives are worse.
But all the Very Serious People, having totally misdiagnosed our problems so far, will probably double down on that wrong diagnosis as markets fall.
Oh by the way. The 10 year bond rate is now down to 2.38% from 2.6% on Friday. The 3 month and 6 month rates are less than 0.01% – essentially zero interest rate.
It’s now Monday morning, Aug 8. It’s been roughly 60 hours since S&P downgraded the rating on U.S. government bonds. In that 60 hours the media, particularly TV talking head channels, have been breathlessly awaiting what they felt was a certain market panic on Monday. Clearly interest rates would go up they said.
They were wrong. The early results are in. U.S. government bond prices have gone up this morning! That means government bond yields (interest rates) have actually gone down! The 10 year bond actually dropped from 2.6% yield on Friday’s close to 2.48% at 9:30 am ET on Monday.
It’s really no surprise if you pay attention to real economic events and not listen to the TV media types who think talking in serious tones is a substitute for actually understanding economics. First, serious investors, the ones who vote with their money in the market already know everything that S&P knows. In fact, they know S&P has a really bad track record. So the rating doesn’t mean much to them.
What does matter is what choices or alternatives they have for investing their money. Right now, the signs from the real economy in both the U.S. and Europe are grim. Europe is struggling to achieve any growth outside Germany with several major economies actually declining due to their governments’ embrace of budgetary austerity. The U.K. is on the ragged edge of another recession, again due to government cutbacks. The U.S. is barely registering postive growth with only 0.8% growth rate in the first half of 2011. It’s clear, too, from the debt ceiling debate that the U.S. won’t be seeing much stimulus anytime soon and likely will join the Europeans in austerity budget cutting. Cutting that will only slow the economy further and possibly drive another recession. So what theses investors know is that economic growth isn’t likely and that’s bad for stocks. Stock markets aren’t the place to be now.
Further, Europe is continuing it’s slow-motion debt default crisis issues. In the past week or so the crisis has spread beyond Greece, Ireland, and Portugal. Now it’s Italy and Spain too. Even AAA-rated France is finding it’s bonds trading at significantly raised interest rates. Now the debt crises in Europe are real problems because the nations inside the Euro zone don’t have control over their own currency, they don’t have a central bank, and they borrow in some other currency (Euro) rather than one of their own. This is unlike the U.S. The problem is the uncertainty the debt crises in Europe are creating. The global financial and economic system is once again showing great signs of weakness, fragility, and uncertainty – just like 2007 and 2008.
When uncertainty abounds and about the only sure thing is that growth will be weak at best, it’s time to put your money in something safe and wait it out. The safest thing in the world (in any volume) is still U.S. government bonds. So what we have is investors moving into U.S. government bonds because they don’t want to be in anything else. Everything else is too risky. So we get increased demand for U.S. bonds and that lowers interest rates on those bonds. This is what financial analysts and economists call a “flight to safety”.
Yves Smith at Naked Capitalism (an unusually good source of very in-depth, timely commentary) offers some strong evidence and analysis of how the S&P decision to downgrade the U.S. debt stinks. I’ve already talked about how it’s really irrelevant at the economic level and how it’s not likely to change things substantially. I’ve also written about how S&P doesn’t have a very good track record.
But Yves, who has extensive connections on Wall Street and in the trading/banking community, brings two other aspects to light. First, this downgrade, along with the threatened downgrade of a few state governments earlier this past week, was leaked before the announcement. The proper procedure is to make such announcements after the close of markets and to not allow any leaks. Leaks constitute insider information. They let selected individuals make profits because they know what’s coming. For example, as Yves suggests, if some traders or banks or others were told in advance, even just a few hours ahead that a downgrade announcement would be made, they could make millions. How? They could either place orders, particularly using derivatives, in anticipation of the move. After the prices of bonds change due to the announcement, you sell. But there’s a simpler way. Just place an
investment bet using the derivatives that based on the volume of trading. Any announcement is certain to trigger a higher volume of trading. Leaking news of announcements is an easy way for S&P to enrich it’s favorite friends. Yves notes:
Treasury yields fell 50 basis points last week despite the risk of a downgrade being very well telegraphed. S&P had asked for $4 trillion in deficit reductions (it tried disavowing that number) and made it clear it was going off to brood and might take action. And this market response took place with S&P leaking like a sieve. Not only was Twitter alight early on Friday with rumors of the downgrade, but some parties purportedly got the memo earlier in the week. From a credible source via e-mail:
Good friend passed on a note from a hedge-funder who thinks the S&P not only fudged its figures for today’s downgrade, but leaked it in-advance earlier this week to a few hedge fund insiders who made a killing off it. That would square with the fake “states face bankruptcy” panic scam earlier this year, which made a few people a lot of fast money.
I assume they did not make a directional bet but went long vol.
So what if bond yields go up 50 basis points on Monday, which is normally a monster move? It just puts us back to where we were last Monday.
So why didn’t investors dump Treasuries with this threat hanging over the market’s head? Maybe investors have wised up and realize the ratings are worthless (more on that shortly).
Yves goes on to explain a bigger, stinkier aspect to the downgrade. It’s politics and a possible we’ll-help-Republicans-if-they-protect-us deal between Republicans and S&P.
Jane Hamsher highlights the hypocrisy of the S&P rating, since it shifted from its 2010 rationale of demographic stress to a February 2011 focus on entitlements. And it didn’t bat an eye at the $2.6 trillion deficit-increasing Bush tax cut extension at year end 2010. More from Hamsher:
Neither Moody’s nor Fitch downgraded US debt at this time. And S&P can’t quite come up with a consistent answer about why they are out there by themselves. It’s like they looked at a public opinion poll, decided that there was no way anyone would argue with “partisan bickering” as a justification, and crossed their fingers that nobody would actually question what it is that they were justifying.
S&P is playing footsie with the Republicans, who are passing bills to relieve them of the legal liabilities that Dodd-Frank exposes them to — even as the SEC is investigating S&P for fraud in the mortgage meltdown.
Some said that S&P wouldn’t dare downgrade the US debt. But it was all over four days ago when Pimco’s Mohammed El-Erian said that S&P was “under pressure” on the US rating.
If you didn’t happen to catch Devan Sharma’s testimony before the House Financial Services Committee last week, this was what he said:
As Dodd-Frank rulemaking progresses, we believe it is critical that new regulations preserve the ability of NRSROs to make their own analytical decisions without fear that those decisions will be later second-guessed if the future does not turn out to be as anticipate or that in publishing a potential controversial view, they will expose themselves to regulatory retaliation.
Pressures of that sort could only undermine the significant progress we believe has been made over the years by rating agencies and regulators alike to provide the market with transparent, quality and generally independent views about the credit-worthiness of issuers and their securities. I thank you for the opportunity to participate in the hearing and I would be happy to answer any questions you may have.
That’s what Rep. Randy Neugebauer, chairman of the House Financial Services Subcommittee said on April 29, when he requested documents from the administration: Treasury officials “may have exerted too much pressure on S&P.” The Republicans were already laying the tracks for S&P’s defense in April.
Here are a few more dots to connect the timeline:
April 18: Mitt Romney: “The Obama presidency was downgraded today.”
April 20: Mitt Romney: “Standard & Poor’s, one of the rating agencies, just downgraded their view of the future for America…If you will, they downgraded the Obama presidency.”
July 15: WSJ — “The Obama downgrade.”
They’ve been cooking this one for a while. S&P will defend themselves from the accusation of overt partisan manipulation by claiming the Treasury “pressured” them not to downgrade US debt. The media will focus on what Geithner did or didn’t say during his meetings with S&P in March and April. Nobody will ask about the ridiculous excuses S&P has made for the downgrades, or the fact that they are trying to wreck the American economy just as they did the British economy by playing God with their austerity prescriptions.
People are focused on the market implications of the downgrade, but that isn’t what this is about. It’s about a President who will now be relentlessly tagged with responsibility for a rating given by a disgraced organization whose victims should have liquidated them long ago.
As Politico reported, White House officials feared a downgrade more than they feared default.
This stinks. I have only quoted the a small part of this story. I urge readers to go to nakedCapitalism and read the whole article. This whole downgrade by S&P is politics. S&P is being used (quite enthusiastically with their cooperation) by bankers and politicians who desire to dismantle the social democratic state.