US downgrade heralds a new financial era - By Mohamed El-Erian
There will be endless debate on whether S&P, the rating agency, was justified in stripping America of its AAA rating and — adding insult to injury — even attaching a negative outlook to the new AA+ rating. But this historic action has now taken place, and the global system must adjust. There are consequences, uncertainties, and a silver lining.
Not so long ago, it was deemed unthinkable that America could lose its AAA. Indeed, “risk free” and “US Treasuries” were interchangeable terms — so much so that the global financial system was constructed, and has operated on the assumption that America’s AAA was a constant at the core, and not a variable.
Global financial markets will reopen on Monday to a changed reality. There are immediate operational consequences, from re-coding risk and trading systems to evaluating collateral and liquidity management. Key market segments will be closely watched, including the money market complex and the reaction of America’s largest foreign creditors.
Meanwhile, for the real economy, credit costs for virtually all American borrowers will be higher over time than they would have been otherwise. Animal spirits, already hobbled by the debt ceiling debacle, will again be dampened, constituting yet another headwind to the generation of investment and employment.
It is hard to imagine that, having downgraded the US, S&P will not follow suit on at least one of the other members of the dwindling club of sovereign AAAs. If this were to materialise and involve a country like France, for example, it could complicate the already fragile efforts by Europe to rescue countries in its periphery.
The future role of rating agencies will also now come under close scrutiny, bringing to the fore the question of who rates the rating agencies? S&P’s action will likely unite governments in America and Europe in an effort to erode their monopoly power and operational influence. This will also force all investors to do something that they should have been doing for years: conduct their own ratings due diligence, rather than rely on outsiders.
