S&P Downgrade: Our Reaction

“Running into debt isn’t so bad. It’s running into creditors that hurts.”  - Unknown

On Friday, Standard & Poor’s lowered the credit rating of the United States to AA+, citing the U.S. government’s “very large budget deficits and rising government indebtedness.”   In April, S&P warned that there is a material risk that, should U.S. policymakers fail to reach an agreement on how to address medium-term and long-term budgetary challenges by 2013, it would, in their view, render the U.S. fiscal profile meaningfully weaker than that of peer AAA-sovereigns. In downgrading the United States., S&P stated that it is pessimistic about the likelihood of the two political parties coming together with a broader fiscal plan that stabilizes the government’s debt dynamics anytime soon. We at SNW Asset Management believe that the downgrade amounts to S&P making a point; it does not change the fact that the United States has a large, diversified, and dynamic economy with one of the strongest legal and accounting systems in the world.  The U.S. dollar is the preferred reserve currency and the Federal Reserve is one of the most independent and well respected central banks in the world. Obligations of the United States are neither more nor less safe, and the intrinsic credit standing of the nation is no different than the day before S&P’s action.

Many of the challenges that Standard and Poor’s has raised  in terms of debt load and the cost of future entitlements have been brewing for years, but they are long-term in nature and our government has the tools to manage these liabilities.  The downgrade, in essence, reflects S&P’s view that policymakers will be unwilling or unable to tackle these challenges due to the “fitful and contentious process” that raising the debt ceiling entailed.  To be fair, S&P’s concern is, if anything, understated: is Congress really ready for an adult decision regarding entitlements, which is the elephant in the room?

The downgrade has caused the ratings of government sponsored enterprises, such as Fannie Mae and Federal Home Loan Bank, as well as certain municipal bonds with heavy exposure to revenues from the federal government, to fall as well.  Again, we do not see the downgrades as having a meaningful effect on these types of bonds that are held in our clients’ portfolios.  The commitment of the U.S. government to these entities has not changed, nor do we expect it to change in any material way.

We continue to believe that the securities affected by the downgrade, including U.S. Treasuries, obligations of the GSEs and pre-refunded municipal bonds are strong credits that are worthy of investment.  The market agrees with us as Treasury securities rallied sharply today due to economic growth concerns.  Notwithstanding S&P’s action, we will continue to invest in securities that are backed by the U.S. government.  As always, we will continue to invest portfolios in securities that have the strong credit quality, deep liquidity, and are within our clients’ investment objectives.