Now They Tell Us: 'Lowering Nation's Credit Rating May Have Little Effect', NY Times Notes Sunday on Page A14

Better late than never, perhaps, but in Sunday’s paper the Times noted that “Lowering Nation’s Credit Rating May Have Little Effect, Economists Suggest.”

The article, by Binyamin Appelbaum article, was buried on page A14 (emphasis mine):

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As political leaders race to avoid a default on the nation’s debts by striking a deal to borrow more money, there is a growing chance that a secondary goal, preserving the nation’s pristine credit rating, might slip beyond reach.

A credit downgrade would probably increase the cost of borrowing for the federal government and for everyone else. But the Obama administration, House Republicans, some economists and Wall Street strategists have concluded that the economic impact would be surprisingly modest, one reason that negotiations over a “grand bargain” for debt reduction broke down.

[…]

Moody’s said on Friday that it would maintain its Aaa rating for the United States so long as the Treasury keeps paying bondholders and Congress passes a long-term deal to extend the debt ceiling. The announcement said that failure to act by Tuesday night, or to meet other obligations, including Social Security payments, would not prompt a downgrade.

The company added, however, that the government still needed to produce a long-term plan to reduce its debts to avoid an eventual downgrade. “The chances of a significant improvement in the long-term credit profile of the government coming from deficit reductions of the magnitude proposed in either plan are not high,” Moody’s said. 

Concerns about a downgrade have also been eased by closer inspection of the potential consequences.

Oddly, because Treasuries have always been considered perfectly safe, many rules are written as if there were no possibility that their status would deteriorate. The federal government, in other words, does not really need a credit rating, which is reflected in the fact that it does not pay a fee to the ratings agencies, while everyone else does.

Banking regulations, for example, accord Treasuries a special status that is not contingent on their rating. Some investment funds, too, often treat Treasuries as a separate asset category, so that there is no need to sell Treasuries simply because they are no longer rated triple-A. 

Also, the concerns of the ratings agencies are focused on long-term Treasury bonds, not the short-term federal debt widely held by money market mutual funds.

In other words, almost no one would be precluded from investing in federal debt, and even the ratings agencies have concluded that few investors would walk away voluntarily. 

The experience of other nations that have been downgraded, including Japan and Canada, both downgraded more than a decade ago, suggests that investors do not necessarily react by demanding higher interest rates.

Finally, there is widespread skepticism that S & P will follow through on its downgrade threat.

“A downgrade of the U.S. government would, in our view, not cause that many investors to dispose of their Treasuries,” Arnaud Mares, head of sovereign strategy at Morgan Stanley, told investors during a conference call on Thursday.

“We think it would accelerate the ongoing trend toward less reliance on ratings in regulation and investment mandates.”

“So the effect,” he said, “would be more on the use of ratings than on the market itself.”

The online version headline was much blander:  “Taking a Closer Look at the Result of a Credit Downgrade.”