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(Copyright Cedar Fair, L.P.)
(Copyright Cedar Fair, L.P.)

Preet Banerjee

Credit downgrade triggers wild ride Add to ...

Stock markets have been on a wild ride in recent weeks. One of the events fuelling the volatility is last week’s now infamous downgrade of the U.S. government's credit rating from AAA to AA+ by Standard and Poor's.

Although things are changing from one moment to the next, the one constant theme is the guessing about what is going to happen next.

Two days before last Friday’s downgrade the markets started selling off and people were scratching their heads as to why. The general consensus was that a tipping point had been reached with respect to all the talk of the debt crises around the world. People were particularly worried about the ongoing drama in the Eurozone and the political grandstanding over the U.S. debt ceiling. So the market selloffs on both Thursday and Friday were attributed to fear which induced selling which begat more fear and induced selling and so on.

After the markets closed on Friday, Standard and Poor's dropped their bombshell. Suddenly, it seemed plausible that news of the downgrade had leaked and that this had been the real trigger for the market declines.

Earlier on Friday, a draft of S&P's report had been sent to the Obama administration. Reportedly, they found a $2-trillion (U.S.) error attributed to spending, which one can surmise would be a pretty big part of the analysis that led to the downgrade in the credit rating. However, after the error was pointed out, the figure was removed from the final report. But the downgrade remained.

The report's justification for the downgrade was due, in part, to the “political brinksmanship” which threatened Washington’s ability to be legally allowed to pay it's obligations.

The $2-trillion error certainly doesn't help ratings agencies as they try to dust off the reputational harm of being directly involved in the genesis of the credit crisis.

Since the downgrade, Standard and Poor's has become a bit of a whipping boy for many commentators.

Barry Ritholtz, author of The Big Picture blog, said this: “Here is the great irony: S&P (and the rest of the ratings agencies) helped contribute in no small way to the overall economic crisis. The toadies rated junk securitized mortgage backed paper AAA because they were paid to do so by banks...It just goes to show you that the old cliché is true: 'You don't need analysts in a bull market, and you don't want them in a bear market.'“

Legendary U.S. investor Warren Buffett went so far as to say that the U.S. rating should be AAAA (which doesn't exist). Ironically, Mr. Buffett’s Berkshire Hathaway is the largest shareholder in Moody's which is one of the other two main ratings agencies. Fitch has also maintained the AAA rating.

Other analysts have said that a AAA rating for any other country is now going to be hard to justify if the U.S. government isn't AAA. When markets sold off this week, the preferred safe haven was still U.S. treasuries as yields actually fell and prices rose.

If further downgrades occur, it may very well be a case of AA+ being the new AAA but we may still see markets trending downwards with each subsequent announcement. But that's just a guess, too.

This week’s U.S. Federal Reserve announcement that interest rates will remain at record lows through 2013 was met with an initial jump in stock prices, only to see them drop precipitously shortly thereafter. The rationale? The government was acknowledging that the economic situation was bad. Stocks fell even though the market already knew this and wanted the Fed to provide stimulus because of it.

If one thing is clear amid all these clouds, it is this: what happens next is anyone's guess.

Preet Banerjee, B.Sc, FMA, DMS, FCSI is a W Network Money Expert. You can follow him on twitter at @PreetBanerjee

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