S+P Decision Triggers Cascading Downgrades - The Dominoes?
By Raj C. Udeshi
The S+P wonks just created a lot more work for themselves. Well they should have known that once you downgrade the United States, there is huge to-do list that awaits you. If the keystone gets chipped, then you’re going to have to readjust everything that is tied to it too. Tons of credit ratings are subordinate to the rating on US Treasuries.
Some must be downgraded because they have macroeconomic vulnerability to the US government (they depend on the full faith and not as good credit of the United States), and others must be downgraded simply because of the sovereign ceiling (no private firm in a particular country can receive a rating higher than that of the sovereign). As seen in 2008 and the 1998 Asia crisis, this sovereign ceiling policy might not be as strictly applied by rating agencies as it used to. (That’s just the kind of arbitrariness they are going for I guess). Here are a few of the dominoes:
- US banks (cannot be higher rated than the country that backs the banking system)
- European countries (in worse shape than the US on debt-to-GDP ratios, and unable to print currency)
- European banks (exposure to Greece + Italy bond defaults, also cannot be higher rated than the country that backs the banking system)
- Municipal Bonds which are pre-funded with escrowed Treasury bonds
- Municipal Bonds backed by Federal leases
- Municipal Bonds for areas with high concentrations of Department of Defense Operations
- Municipal Bonds for states and local governments that depend on Federal spending
- Municipal Bonds for agricultural entities (although government farming subsidies are at all-time low)
- Fannie + Freddie (fully guaranteed by US Treasury – already downgraded)
- Israeli sovereign debt
- Mortgage REITS (mortgages backed by Fannie + Freddie, and leverage decreases, so not as much profit)
- Insurance Companies (who may hold US Treasuries + municipal bonds that are closely linked to Federal debt – Northwestern Mutual, Teachers Assurance & Annuity, USAA already downgraded)
On a macro level, here is what the cascading downgrades scenario looks like. I used the HiddenLevers scenario hedging screener, to discover some safe harbors. Here are two:
Fund |
Ticker |
Expected Performance |
1Y Return |
PIMCO StocksPLUS TR Short Strat Instl |
24.73% |
-11.43% |
|
Van Eck Intl Investors Gold A |
11.29% |
21.84% |