Don’t Let the Debt Downgrade Scare You

Although it was well-telegraphed, I was still plenty surprised when Standard & Poor’s downgraded the United States a notch from the highest credit rating AAA to AA+. But it seems I am now one voice in a growing chorus that believes Standard & Poor’s made a massive mistake. Some might think the rating change to be a nuanced difference, but having held the coveted AAA moniker since the inception of credit ratings 70 years ago, the U.S. downgrade was quite significant from a psychological point of view and less so from a financial point of view.  I focus on the psychology because the actual report was so light in its fiscal critique–even though I readily admit we have deficit issues that must be addressed. In fact, S&P’s report seems to downgrade America’s political system more than anything else.

If S&P held the pristine reputation it once had, a stock market sell-off might have made sense. But the organization’s credibility has been seriously in question since the depths of the last financial crisis when it gave AAA ratings to the toxic subprime mortgages that propelled the liquidity crisis that took our financial system to the brink in 2008. It is worth noting that as I write this column, S&P’s main competitors, Fitch and Moody’s, have maintained their AAA ratings on the United States.

Normally, a lowered credit rating tends to cause interest rates to rise based upon a reasonable view that more risk is at hand. But so far, the opposite is occurring; interest rates for U.S. Treasuries have fallen–thereby underscoring their place in the world as the most secure investment one can make. More specifically, on those days when we have seen significant stock market losses, nervous

investors have been flocking to, of all things, U.S. Treasuries! Simply put, U.S. government debt cannot be riskier and simultaneously remain one of very few safe havens in a panic. Taking this argument one step further, I ask a simple question: Does anyone believe the United States is less creditworthy today than it was in the middle of the 2008 financial crisis? If the answer is no, than either we should have been downgraded then, or the current downgrade makes no sense since it supposedly captures an increased risk of default.

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In my view, U.S. Treasuries will remain a virtually risk-free security regardless of what S&P says–making AA+ the new AAA. For one, as the great Warren Buffett has noted, the U.S. “owes no money in currency other than the U.S. dollar, which it can print at will.” That is

not true of European countries who are all tied to a common currency–the Euro–which they cannot print. About 45% of our sovereign debt is held abroad by countries such as China and Japan. If those foreign entities agreed with Standard & Poor’s they would abandon Treasuries, which has not happened. The reason being, foreign investors, especially large central banks, have two choices aside from U.S. Treasuries: slim and none. Given the recent market turmoil, European sovereign debt is looking riskier by the minute. Moreover, the BRICs (Brazil, Russia, India, and China) are nowhere near ready to stand in as any sort of global reserve. When taken in a global context, we think foreign investors are now more likely to bulk up on Treasuries than pull back.

So, what does this mean you should do? That’s the simple part: nothing different. I don’t believe the unfortunate downgrade of our great nation should cause you to change your view of the country, its credit, the stock market, or anything else, frankly. In the words of Vanguard founder John Bogle: “Don’t do something, stand there!” You should examine your asset allocation to make sure it remains in line with your long-term goals.  Continue to invest as much as you can in your 401(k) or IRAs. If you have cash and agree with me that the stock market is once again cheap, by all means buy prudently. But most of all, do not panic and do not sell just because we dropped half an “A.”

Mellody Hobson is president of Ariel Investments L.L.C., a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds. She is also a regular contributor to ABC’s Good Morning America.