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Tuesday, April 19, 2011

Is there a material problem from losing "AAA" status?

In short, the AAA status will be lost or not lost in the marketplace long before a credit rating agency actually decides to downgrade U.S. treasuries. Markets always are about two or three steps ahead of the rating agencies. Look no further than any of the recent sovereign debt crises or the 2007-2008 debacle with mortgage backed securities.

The one material effect is in the investment policies of pension funds and endowments where there are certain requirements as to the percentage of AAA assets that need to be held as a portion of the portfolio. If U.S. treasuries aren't considered AAA, it would be hard to imagine what would step into the void.

As far as the likelihood of a downgrade, that is hard to say. If Congress actually decides to grow up and face the long-term deficit problems like it has a spine, these are not insurmountable issues. A few modest tax increases and well balanced spending cuts would do the trick in a hurry. However, an unfortunately large number of representatives have decided to invoke moral absolutes, which should almost never be part of this process. As a result, we are not looking too good at the moment. Perhaps the S&P warning may have been enough to get people thinking a little more clearly.

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