But isn't this exactly the sort of action that both Washington and Wall Street had been calling for over the past couple of years? S&P had developed an opinion about a risk that the market faces -- political risk due to severe partisanship in the U.S. -- and boldly took rating action as a result. It decided to lead on this issue, instead of reacting to the market. Even though the other two major rating agencies disagree; even though the market disagrees; even though Washington broadly disagrees, S&P is standing firm in its conviction that U.S. debt should not be rated AAA.
And perhaps this is sweet justice to S&P. Both investors and politicians have broadly skirted blame for the financial crisis. Investors could have better analyzed those toxic mortgage securities themselves before investing their billions of dollars in them, blindly relying on the agencies. Washington could have made the agencies' ratings less significant over the years, instead of making them more and more important throughout finance, as they permeated throughout statues from regulation to capital requirements.
But Will S&P Be Vindicated?
Some investors and even politicians do agree with S&P. They worry that U.S. debt will eventually run into problems and that Washington doesn't have the will to venture off its unsustainable path of high spending and low taxes. We won't know if S&P and those who support the downgrade are correct for some time, however. U.S. debt is under no threat of default in the near- to medium-term. Instead, S&P's decision is based on longer-term political risk.
And it's possible that Washington could have a new motivation to reduce the deficit, in part to prove its critics like S&P wrong. If it channels its anger at S&P as greater willingness to compromise more effectively in the future, then the agency may have been proven right if its downgrade had never occurred, but the world could never know of that alternate reality.
Early Monday morning, however, the market doesn't seem all that moved by S&P's verdict. At 10:45am EST, Treasury yields had actually declined a little. The Dow opened down, but only by 10:45 it had declined by less than 350 points. That's not good, but it's hardly a bloodbath. At this point, the market seems to be displeased with, by not panicking over, S&P's downgrade.
These results imply two things. S&P has already lost so much credibility over the years, that a historic downgrade of U.S. debt isn't violently shaking the market. More importantly, however, many investors disagree with S&P: despite the downgrade few are more worried about U.S. debt on Monday than they were on Friday.
Image Credit: Jonathan Ernst/Reuters