4 Things to Remember About the Credit Downgrade

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Five days, a stock market plunge, and a flurry of finger-pointing later, we're still trying to figure out what Standard & Poor's downgrade of U.S. Treasuries really means. Here are four points I'd keep in mind.

1. It had no impact on Treasuries.
The biggest risk of a Treasury downgrade was the possibility that interest rates would rise. That could add trillions to future federal borrowing costs and stifled economic growth.

But interest rates didn't rise at all after the downgrade. In fact, they've plunged. Monday turned out to be the eighth best day for 10-year Treasuries in modern history. The biggest irony of downgrading Treasuries is that it instantly increased global demand for ... Treasuries. One blogger, mocking the stereotypical investor, quipped: "Treasuries were downgraded? Wow! Sell my entire stock portfolio and get me into Treasuries!"

How do you explain that? It's simple. The risk that led to the downgrade was political. But financially, Treasuries are still the safest, most liquid assets in the world . And the U.S. still has the means to pay its bills. That isn't a question. Investors still flock to Treasuries whenever there's a panic. It's where they feel safe. Incredibly, the Treasury can borrow money for 10 years today at less than half the interest rate offered a decade ago, when the government ran surpluses.

2. It will have no impact on banks.
Banks are required to hold minimum levels of buffer (capital) against certain assets. Risky assets require big buffers, less risky assets require smaller buffers, and Treasuries require basically no buffer at all, since they're considered risk-free.

That could have changed after the downgrade. Without a pristine credit rating, the rules regarding how much capital banks have to hold against Treasuries could have been rewritten, forcing them to scramble to raise more capital. This could have been gut-wrenching, since Bank of America (NYS: BAC) , Wells Fargo (NYS: WFC) , Citigroup (NYS: C) , Goldman Sachs (NYS: GS) , and JPMorgan Chase (NYS: JPM) collectively own almost $1 trillion worth of government securities.

But within minutes of the downgrade, the Federal Reserve issued a statement making it clear: The downgrade will not change how much capital banks are required to hold against Treasuries. This was an incredibly important development that went largely unnoticed. Anything different could have sparked a banking panic. Be thankful for it.

3. The rating agencies' credibility is dubious.
S&P downgraded the nation's credit due to political bickering. That political bickering is mostly about the massive accumulation of debt in recent years. And why has debt exploded in recent years? Because of the financial crisis. And who caused the financial crisis? If you had to come up with five broad culprits, the rating agencies would be one of them. We could not have had a housing bubble like we had without the rating agencies. And we wouldn't have today's deficits without a housing bubble.

Think of it that way, and S&P effectively downgraded itself.

Now, mentioning S&P's housing-bubble fumbles when criticizing the recent downgrade is misleading. While they work under the same roof, the analysts who rate housing bonds are not the same analysts who rate sovereign debt.

But there's another valid criticism beyond S&P's past performance. As I wrote on Monday, S&P's original downgrade report had a glaring math error. When that error was corrected, the nation should have, by S&P's original standards, been in the clear for a stable credit rating. Instead, the revised report changed the benchmarks so that forecasted deficits still fell into a danger zone.

The snafu underscores an important point: S&P's downgrade is the opinion of one very fallible group of people. It's outrageous to think that it should shift the path of the global economy.

4. If there's anyone to blame, it's us.
S&P made it clear: the credit downgrade was mostly a demotion of our political system. Our deficits are large, but our political infighting is massive.

Motley Fool co-founder David Gardner asked an important question yesterday. Paraphrasing a famous Warren Buffett quote, he asked: "Would you be willing to put every last dollar you have into the hands of this particular public official to manage on behalf of our future?"

David didn't mean it literally. But "we stand a far greater chance of improving, rather than further undermining, our creditworthiness as a nation if we as its citizens begin to ask this Buffett question of ourselves prior to casting votes," he wrote.

I think you can take it a step further. A recent poll shows that just 14% of Americans approve of Congress's performance. Another showed most Americans would vote out every member of Congress, regardless of party, if they had the chance.

The amazing thing about that statistic: They do have the chance. They can vote.

Yet so many choose not to. In last year's elections, just 37.8% of the voting-age population made it to the polls. 30 million more votes were cast for last season's American Idol than for last year's Congressional election.

Think about that. The majority of those who disapprove of Congress's performance don't even bother to vote. These people have very little right to complain, in my view. 

If you're sick of what's been going on lately, and appalled about the debt downgrade and its impact on your investments, do something about it. Vote.

Fool contributorMorgan Houselowns Bank of America preferred. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of JPMorgan Chase. The Fool owns shares of and has opened a short position on Bank of America. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.



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