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Morgan Housel
April 19, 2011

Monday morning. Nine o'clock. Everything's calm in the global finance world.

Then Nikola G. Swann, a relatively unknown analyst at Standard & Poor's, downgrades the United States' debt outlook from stable to negative. He puts the odds of an actual downgrade -- losing the AAA seal of approval -- at 1-in-3 within the next two years.

Markets panicked. Stocks took a big hit. Gold rose. Treasury yields actually fell, but who knows what that means. The Federal Reserve is buying up to 70% of Treasury issuance. Nothing that market does should be taken seriously.

What's interesting is what S&P's report said. Or rather, what it didn't say. There was nothing shocking in it. Nothing bold. Nothing new. It didn't even include many numbers. Just a rehash of what's been reported ad nauseum over the past three years.

"More than two years after the beginning of the recent crisis, U.S. policymakers have still not agreed on how to reverse recent fiscal deterioration or address longer-term fiscal pressures."

Yes. Well-known.

"In 2003-2008, the U.S.'s general (total) government deficit fluctuated between 2% and 5% of GDP. Already noticeably larger than that of most 'AAA' rated sovereigns, it ballooned to more than 11% in 2009 and has yet to recover."

Right. It's been in all the newspapers.

"We see the path to [political] agreement [on reducing the budget] as challenging because the gap between the parties remains wide."

Mmm, think I've heard that one before.

This isn't a critique of S&P. Rather, it's a critique of the market's reaction. Two weeks ago, it was discovered that PIMCO's Bill Gross -- one of the world's foremost bond authorities -- was short Treasury bonds. Markets didn't so much as blink. But when one Nikola Swann rehashes what's already widely known, it shuddered.


Some might still take the ratings agencies seriously. But there may be a couple other reasons investors panicked after S&P's call.

1. Regulations 
For years, banks have been required by regulators to set aside a specific amount of capital based on how risky their balance sheets were. Who determines that riskiness? A ratings agency blessed by the Nationally Recognized Statistical Rating Organization. Only a handful of these organizations exist, and the only two large enough to be relevant are Moody's (NYSE: