Dear Everyone: Stock Market Problems Are Not Directly Due To S&P Downgrade
from the how-to-read-a-market dept
This morning we posted about the total silliness of people overreacting to S&P downgrading US debt from AAA to AA+. We received a couple of "you clueless idiot" type comments, with people pointing out that this "matters" because some institutions are required by law to hold certain percentages of certain grade investments. Of course, we did mention that in the post, so I'm going to take the blame and admit that I perhaps wasn't clear enough and now will try again: my point is that it's stupid that anyone has to react because one firm (with a rather poor track record) in "rating" debt suddenly makes a slight shift in its opinion, and that such a change in opinion represents no real change in how people view the market.My point -- which again, was perhaps not clear even though it was the final line of the post is this:
Markets are made based on the interaction of buyers and sellers. Not the (sometimes questionable) opinions of just a few firms.Now, let's prove it. All of the press reports today are saying that the stock market collapse is due to the S&P's downgrade. And that may be true in a very indirect way (which we'll get to), but there's no way it's a "direct" response. Here's why: the S&P is saying that US debt is just ever so slightly riskier than it was before. If that's true, then the market would likely be dumping treasuries and the interest rate would be going up. Instead, the exact opposite is happening. It looks like buyers are flooding into treasuries and the interest rate is dropping. Even economists, who generally take totally opposing opinions to one another, are trying to point this out. You've got Paul Krugman (self-described liberal) complaining about people missing this point... and you've also got libertarian Arnold Kling making the same point.
Now it could be that the downgrade indirectly triggered the stock sell-off, but it's not because S&P is suddenly afraid of the US debt being less trustworthy. As Kling notes (and I suggested in my original post), the market already can determine how risky US debt is and has priced that into the market. One firm's opinion should not change that. If anything the action in the market suggests that people are rejecting the S&P's change, not freaking out because of it.
So then why is the stock market dropping? There could be a variety of indirect reasons. One might just be that some investors are generally overreacting to the news without understanding it at all, and thinking "bad news means sell." Another theory is that this move jolted some people's attention to larger problems elsewhere (mainly the fear of Italy running into trouble). But I actually tend to think that Krugman's analysis here is actually the most reasonable. He argues that the reaction in the stock market means that US policy makers are about to overreact badly, because of the S&P downgrade, and do something stupid to harm the economy even more:
And maybe, maybe there is an S&P story � but not the one you think. Arguably, that downgrade will bully policy makers into even more deflationary, contractionary policies than they would have undertaken otherwise, which has the perverse effect of making US debt more attractive, since the alternatives are worse.But, why isn't anyone talking about a very serious problem: the fact that we allow ratings agencies to have so much power in the first place? A ratings agency is just an opinion. What's wrong with letting the market set the opinion of the likelihood of default on debt, rather than suddenly trusting firms that don't have the greatest track record?
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Filed Under: debt, markets, ratings agencies
Companies: s&p
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Why?
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Splitting hairs
Mike, I really agree with your overall point, but I've got a problem with this statement. Maybe I'm splitting hairs, but here's the statement I would make:
Market prices are based on the interaction of opinions of all buyers and sellers (rational or not).
Anything which changes the opinions of buyers and sellers does have an impact on the market. Yes, its stupid and insane that 3 companies with questionable motives, having conflicts of interest, and a poor track record, can have this much power, and even worse that its legislated that they do.
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Re: Splitting hairs
THIS. The very fact that these institutions can and do make money off of their own ratings is ridiculous. They are legalized maniuplators of the market....
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Re: Re: Splitting hairs
Pay no attention to them rating toxic mortgages as AAA.
A sure sign of them taking the meltdown seriously would have been an overhaul of how these companies do business.
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Re: Re: Re: Splitting hairs
I approve this message. ;)
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Re: Re: Re: Splitting hairs
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The sheep principle
That is effectively everyone knows the way to make money (or prevent losing money) is to be among the first to take advantage of a situation.
So if you believe (rationally or not) that the market is going down you sell. If you believe others believe the market is going down and therefore they will sell you sell... and so on...
My experience in trading desks on bear and bull markets is that this is very powerful. Everyone wants to follow the leader and either buy or sell regardless of the facts or reality of the situation.
Its good old fear and greed wrapped up in one!
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That's exactly what it is.
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Hilarious. I explain in detail why it's not and your response is just to state that it is? Very convincing. However, you are dead wrong and I can prove it. If you were right, the rate on treasuries would have gone up. But it went down. So, people didn't raise the price on debt (which they would do if it was riskier), but lowered it.
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Ratings agency power
I'm sure this was mentioned in comments to the last post, but in case it wasn't it should be noted that Dodd-Frank included two shots across the ratings agency bows: 1) it removed their exemption from expert witness liability and 2) it required federal agencies to remove "baked-in" reference to ratings agencies from the regulations they promulgate. Both of these had the potential to seriously impede the ratings agencies. In fact after the law made them responsible for their opinions they immediately began refusing to allow their ratings to be published (although the SEC appears to have given them a perpetual waiver and a bill to remove this provision has emerged from the House subcommittee a few weeks ago without much fanfare). Of course, both reforms appear to have been eviscerated through the typical process of backroom dealing and regulatory capture. Whoops!
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Treasuries are generally considered a safe haven. The S&P ratings change didn't do enough to US bonds to make them unpalatable, AA+ is still such a high rating that few are even at that level. The change in the rating by itself isn't enough to discourage buyers.
What you are seeing today is the "sideline" of the S&P downgrade, which is their belief that the US system currently will not recover in a manner that will increase tax revenue, and that it is likely that the US will face another recessionary period. That is much more likely to be the trigger from the S&P comments.
What you end up with is a situation that 10 year bonds yielding just under 3% a year are still much better, at least in the short to medium term, than the eonomy itself. So people are "buying into safety" and liquidating out of stocks, which during a recession are generally hit very hard.
With the European situation, there is less "good news" out there to support stocks, leaving the US treasuries as still a pretty safe haven. This concept is backed up by continued increases in the price of gold, which is the oldest "safe haven" around.
So S&P's downgrade by itself didn't trigger this, but their underlying sentiment may just have done it.
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Also, an interesting point for those of you that dont understand economics, while it might be good for investors that treasury bonds accumulate interest at a faster rate than the economy grows, you should be aware that its still probably under inflation (which is the metric that matters), and also, if the government is paying more interest on bonds it issues than it grows its revenue, then that delta will some day be paid out of taxpayers wallets.
Another thing most of you ACs dont tend to take into account (or really anyone) is that the US government might be 14.5 Trillion dollars in debt, but there is another 40 trillion in expenditures over the next 10 years the government has ALREADY LEGISLATED IT WILL SPEND that it cant pay for. Not spending that money is just as much breaking the law as spending above the debt ceiling. Basically, I don't like Obama either, but until he starts violating the separation of powers, its Congress's fault and only Congress's fault that you are in this mess.
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With oil prices dropping rapidly, and the potential for lower consumer spending /demand in a continued recessionary period, the concepts of negative inflation (deflation) are a real possiblity.
In deflationary times, a solid, assured, AA+ bond paying 3% would be golden.
My disagreement with the article is that Mike appears to be saying that the S&P downgrade had nothing to do with this. But the full language of the S&P downgrade, and all that is run with it in the media over the weekend has made it clear that the US economy might be on track for a net 1% of less growth this year. So the big event of the downgrade isn't key, the language and spin that goes with it is.
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Except Obama proposed and/or signed a lot of that.
I found the whole debt ceiling thing silly. Congress passed deficit budgets and then acted surprised when the debt went up. The proper time to debate all of this was while passing the budget.
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Next year, I could actually see Treaury bond being rated as junk bonds. Y'know, like that other crazy socialist country. Err, Greece.
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My point is that the S&P downgrade does have an effect. Trying to say it doesn't is to deny reality, but it is because of the wording used in the downgrade, not the downgrade in and of itself.
It's nice when you read comments by only looking at the posting IP and making a snide comment.
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Nice!
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In fact, it discouraged them so little the market decided they're even more valuable than before. In other words the market disagreed with S&P's assessment.
If treasury bonds are still super-safe, why did S&P downgrade them, instead of stocks? I'm still not seeing the connection you're trying to draw between the S&P saying US government debt is less reliable, and subsequently their price rising while stocks' prices fell.
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By the way, this is the exact same ratings dip that Lehman took like 4 days before it went completely bankrupt, so, no, these ratings dont have an effect. The market for treasuries has an effect, not the assholes talking about it, at least not seriously.
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But if they don't PROVIDE the opinion, the public might come up with their own....
Or perhaps I just had too much coffee this morning.... Sometimes it's hard to tell if there is really something going on behind the scenes, or if it's just a bunch of smoke and mirrors.
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What's in a Name
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Tech blog?
Why are we reading about finance on a tech blog?
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Re: Tech blog?
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I think that's what's going on now... the market is deciding. Rather obvious, don't you think?
allow them to have so much power??? They have no power. They state opinions. Fidel Castro has power. It comes out of a gun.
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Not in the slightest. The only thing that changed over night was a AAA rating dropping to AA+.
It would be like a food critic panning a highly popular restaurant and causing a sudden plummet in business. The food didn't change in the slightest, just a single opinion being voiced.
If what you're saying is true, the stock drop would have happened regardless of what the credit rating was stated to be.
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In fact, who is to say that the downgrade isn't propping up the market now that the rating agency is calling the piece of shit... that's right... a piece of shit and not a chocolate bar?
Has this in fact given the rating agency more credibility that they won't print AAA on the securities of those who pay their bills even if they don't deserve the rating?
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There are certain purchases that are, by law, affected by the rating agencies' opinions. So their decisions are ultimately (very indirectly) backed up by guns.
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"just ever so slightly riskier than it was before" = -634.76
The "Plunge Protection Team" is pouring paper dollars into the stock market to prop it up (that's why the uptick near end of most days), but it's lost effect now. And the Federal Reserve (which is neither Federal nor a "reserve") is "buying" Treasury bills to prop them up (then US taxpayers supposedly /owe/ the Federal Reserve for "money" that never existed!). -- All are RACKETS by The Rich, looting the country by way of PAPER FRAUD.
No one can really predict what will happen when faith is lost: may rally again, but you are right that this isn't sudden.
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I see a country in decline. Instead of focusing on the basics to make this country stronger, this latest wake-up call has everyone pointing fingers at everyone else, including blaming the messenger S& P. SO we'll just trot along in ignorance, declining just slowly enough to remain oblivious to what's happening until it is too late.
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Screaming fire at the theatre
They were yelling fire in a crowded movie theater either way.
There are no "fundementals" in the markets, just a lot of sheep that scare easily.
Calling S&P "merely a messenger" is rather disengenuous.
That's not even getting into the rest of their crap.
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not about S&P, it's a headfake
This article in Asia Times points not to the end of the world, but to the end of...hedge funds.
http://www.atimes.com/atimes/Global_Economy/MH09Dj02.html
Investment schemes tend to work well until lots of people adopt them, then they stop working. Big investors like CalPERS went to hedge funds for returns that they couldn't get elsewhere. Now that magic no longer works. So investors are cashing out, causing hedge funds to liquidate. When it's all done, what will those big investors do with all that money? Treasuries? Of course not. Corporates? They are borrowed out at low rates and have more cash than they can use. Japan bonds? China just dumped ~$6b of those. That leaves bluechips, which is why Buffet is loading up.
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The level of denial in the US is astonishing !!
It really does show the extreem level of denial you are in.
Do you not have any concept of "cause and effect", that may be the S&P rating changing is the effect, and not the cause?
The cause of the fiscal problems the US is facting is due to its massive borrowing from foreign countries, and massive spending, and the huge waste of money going to fighting a failed and false war in the middle east.
The fact that you have a very poor manufacturing base, and are losing IP and skills to other countries are an extreemly high rate.
You dollar is going down in value, your manufacturing industry is in tatters, you are selling IP and skills to overseas and you have massive financial management problems, and massive debt.
It is not the S&P's fault, or the fault that the rest of the planet can see what it appears those in the US are incaple of seeing. The world markets reflect that fact.
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Re: The level of denial in the US is astonishing !!
You mean the statements where I noted that the US financial situation was a mess? Or are you making stuff up again and pretending I said otherwise.
The fact that you have a very poor manufacturing base
Actually, largest in the world, thanks for playing...
Kinda tough to take you seriously darryl.
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OK, I'll put my conspiracy theorist hat on now
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Seems unlikely considering the massive spending binge our government is on ... the problem is the debt... you don't get out of debt by spending more.
For all the talk about "cuts" the plan is to spend more money this year than last, and more money next year than this year.
Cuts are when you spend less money than you did prior. So far they haven't suggested trying that action.
They won't allow deflation to happen because of our debt load. My money is on the coming inflation.
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