Even those that don’t follow the financial markets daily became fixated this week on the downgrade of the United States' credit rating by Standard & Poor’s. In this week’s article I wanted to answer the question, ‘Who is Standard & Poor’s' and also share with you some some additional forecasts made by this organization. Although not given headlines, these lesser reported forecasts will likely have an enormous impact on us all.
Who Is Standard & Poor’s
The company, started back in 1860, represents one of the three major financial ratings services (in addition to Moody’s and Fitch). Standard & Poor’s rates borrowers on a scale from AAA to D. They are also the creator of the widely followed Standard & Poor's 500 stock index (comprised of 500 of the largest publicly traded U.S. stocks). The United States rating of AAA was lowered one step on the ladder to AA+ on August 5. For anyone that has taken college level economics it has long been a principle that U.S. treasuries represent the gold standard in safety. Tear that page out of the texbooks, the U.S. is no longer king of the financial hill.
Countries with AAA Ratings (now considered a better risk that the U.S.)
Australia, Austria, Canada, Denmark, Finland, France, Germany, Guernsey, Hong Kong, Isle of Man, Liechtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland, United Kingdom
The Real Reason The U.S. Lost It's AAA Rating
Our current financial predicament was really misunderstood by President Obama, who emphasized raising the debt ceiling as the primary issue needed to avoid a rating downgrade. In actual fact, it was not as much whether or not the government authorized itself to take on more debt but its overall financial standing. The meager budget cuts that accompanied the increase of the nation's debt was the reason for the loss of our credit rating. It is a mathematical certainty that the U.S. will collapse financially within 5 to 7 years if major budget improvements are not made, so maybe this is a needed wake up call.
Who Else Is Under Scrutiny From Standard & Poor's?
On Monday, shares of Bank of America plunged 20 percent losing almost a third of its value. Shares of Citigroup, the third-biggest bank, fell 16.4 percent on Monday. This due to warnings from Standard & Poor's about a dim outlook for many major banks. Chiefly among the concerns continues to be the exposure to bad mortgages. Fannie Mae and Freddie Mac also had their ratings cut from AAA to AA+. Now deemed a 'higher risk', this will likely lead to a spike in mortgage rates in the coming months.
Is your bank safe? There were 157 bank failures in 2010 and 64 in 2011 so far. I have written about bank safety and have always seemed to touch a nerve when I have done so. Yes, you do have FDIC insurance but you would still be better off staying away from potentially troubled banks nonetheless. Now that we are all in uncharted waters let's not take anything for granted. Check out your bank's safety rating today at BankRate.com.
State And Local Governments
If you have money invested in municipal bonds, your investment may not be as safe as it once was. If the rating declines for the issuer of bonds you are holding, the market value will decrease. Although your interest payments may continue, if you need to sell you bond prior to maturity you will likely get less than 100 cents on the dollar. Even worse, you may lose your money altogether if the issuer of the bond defaults. Default risk is much greater on revenue bonds which are only guaranteed so far as the underlying project. Revenue bonds will pay a higher rate of interest, but if the airport or other municipal project fails financially you are left holding the bag. Here is a great article on understanding municipal bond investment risk.
Even if you are not a holder of municipal bonds, you may still be at risk if you are the beneficiary of a pension from a state or local government. While there is not much you can do if your benefits are reduced, now would be a good time to increase savings and pay down debt. If possible, develop a contingency plan for a reduced pension benefit. For many, this may involve part time employment or starting a small business.
Now is not the time to take your eye off the ball. You should sit down and make a determination of what risk you can afford to take and adjust your investments accordingly. If you need assistance, consult with a Christian Financial Planner that can work with you on a fee basis (does not sell investments). This may also be your last chance to refinance at a decent rate, so if you have been considering doing so don't wait too much longer. I think higher interest rates are coming very soon.
I remember hearing the stories my grandparents told me about the 'Great Depression.' After this week. we all now have our own stories to share with our grandchildren, for we are living in truly historic times.
Helping you make the most of God’s money!