Since the agency has taken away the nation's pristine credit rating, those firms and entities that depend on it will also suffer
We saw this coming: S&P's downgrade is infecting other firms and entities connected to the U.S. Some of these ratings actions should be significant enough on their own to warrant some concern in the market. A U.S. downgrade does not occur in a vacuum -- far from it. Several very significant financial players also rely on the full faith and credit of the U.S., and S&P's rating action casts doubt on the U.S.'s ability to live up to those promises as well.
Fannie, Freddie and Other Government-Related Entities
Since the U.S. government seized troubled mortgage companies Fannie Mae and Freddie Mac, their unsecured debt took on the same risk as Treasuries. After all, the U.S.'s promise to pay those companies obligations isn't any stronger than its promise to pay interest and principal on its own bonds.
Consequently, S&P has downgraded the senior debt of Fannie, Freddie, and a number of other government-related entities from AAA to AA+. Its action includes:
- Fannie, Freddie unsecured ("agency") debt
- 10 of 12 Federal Home Loan Bank debt (the other two's debt was already rated AA+)
- Farm Credit System debt
- 30 financial institutions' debt that benefits from the Federal Deposit Insurance Corporation's Temporary Liquidity Guarantee Program
- 2 corporate credit unions' debt that benefits from the FDIC's Temporary Corporate Credit Union Guarantee Program
Israeli Bonds Guaranteed by the U.S.
One nation is directly affected by the U.S. downgrade: Israel. The state has sovereign debt guaranteed by the U.S., and it has been downgraded from AAA to AA+ by S&P, just like the U.S.'s debt. The action affects nearly $6 billion in debt issued by Israel.
S&P has also downgraded the long-term counterparty credit ratings of major financial clearinghouses, deemed to benefit from an implicit U.S. guarantee. They include:
- Depository Trust Co. (DTC)
- National Securities Clearing Corp. (NSCC)
- Fixed Income Clearing Corp. (FICC)
- Options Clearing Corp. (OCC)
These clearinghouses play a central role in the derivatives market. This move could result in those trading derivatives demanding greater additional capital as protection from a counterparty default. At this point, the Federal Reserve has already said that capital rules should be unaffected by the U.S. downgrade. S&P's move could cause some market panic, however.
This is what we know right now, but we might see other debt downgraded as well. Municipal bonds come to mind, as many states are expected to benefit from implicit federal guarantees. Some insurance companies also might be affected. The downgrades may continue to roll in, as S&P warned in its U.S. downgrade note.
Image Credit: ℒaura Tourette's/flickr
We want to hear what you think about this article. Submit a letter to the editor or write to email@example.com.