Don’t Blame the Messenger (S&P)

This column is normally dedicated to a discussion of the recent regulatory and industry news affecting the securitization industry and we have usually tried to stick to the script.  However, we feel that the announcement by Standard & Poor’s on Friday August 5th that they would take their rating of US debt down from AAA to AA+ is worth noting. 

The fact that S&P, in their initial report and in the strong defense of their decision during a conference call over the past weekend, pointed out the obvious that the primary rationale behind their decision to downgrade was not whether the US has the means to meet its obligations but whether the “political risk” associated with the never-ending logjam in Washington, D.C., makes the downgrade both appropriate and necessary.  What S&P is saying is that for the first time in modern history, holders of US debt should envision a number of scenarios where the US “might” not honor its obligations.

We found the reactions to the downgrade in both the Administration and Congress to be laughable.  You have to ask yourself, “what show they have been watching for the last year”; it certainly hasn’t been the Potomac Circus that the rest of us have been watching.  Clearly this is a great example of those howlers being much to close to the “action” to be anything close to objective.  Let’s face it, Washington politics are now the mostly highly rated Reality TV Show in the US.  All S&P is telling them is that we have been watching and with every side-show event that goes by, the Washington pols continue to sap the market’s confidence in both their grasp of how the markets work and their abilities to make good policy.

The downgrade should not be overstated in that it is really only a bucket of cold water on the US Government.  Certainly no sane investor is going to continue to believe that US Treasuries are anything but the safest bet around.  Nevertheless, particularly the obviously unenlightened members of Congress (both House and Senate) need to understand that there is nothing etched in stone that says that US debt will always retain the same status we have enjoyed and benefitted from since before many of these folks were born.

We imagine that many of you who have been following the bond markets for years can’t help but chuckle about how similar the reactions by Treasury officials, members of Congress and the Administration sound to all those grumblings by corporate  CEO’s and CFO’s, over the years, immediately following their meetings with the rating agencies in a last-minute attempt to avoid downgrade.  This, by the way, sounds exactly like what must have been going on late last week at the Treasury Department, as they attempted to avoid the inevitable.

We don’t think it is stretch to tie this back into the overall mismanagement of the legislative and regulatory reactions to the 2007 Financial Crisis and, in particular, the securitization markets.  The failure of the politicians to grasp even some of the most basic market fundamentals in first prescribing and then implementing changes to the system is brightly illuminated by the “Doesn’t S&P understand that we just solved the problem” reactions, across the board, in Washington.  The securitization markets have been equally “unimpressed” by the content quality and the speed of implementation to changes in their markets as S&P (and the rest of us) are about how Washington solves fiscal policy problems.

What the US economy needs is more “Balance Sheet Capacity”.  We can think of no better solution then fully restoring the abilities of banks and other originators of assets to leverage their balance sheets through securitization.  This does not mean a return to the excesses of the early 2000’s because we continue to believe that, if the regulators had effectively utilized the regulations that were already in place at that time, much (maybe all) of that excess would have been avoided.  Instead, the cure has been to return banks to management strategies which resemble the 1950’s.

Perhaps this S&P “wake-up call” will reverberate across all the legislative and regulatory bodies that have been so overly focused on “elementary school economics” and “change simply for the sake of change”.

About markferraris
Managing Principal Orchard Street Partners LLC

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