26th July 2011
Yesterday Mindful Money picked up a similar sort of sentiment, from the message boards where commenters felt that treasuries should be avoided but do Salmon's loyal readers all agree? First an excerpt from Salmon's argument.
He asks: "So what happens if the US loses its triple-A? The simple answer is that nobody knows. But it will certainly cause second thoughts among people who up until now have been very good at ignoring the question of credit risk in triple-A assets.
"We believe that our investments are worth whatever they're changing hands for today, even though we're not selling them today, and any state of the world where lots of people wanted to sell those investments is a state of the world where they'd likely be worth much less than they are now.
"The single biggest beneficiary of this suspension of disbelief is the USA. Because everybody believes Treasury bonds to be risk-free. But a world without triple-A debt is a world where investors are more alive to the risks that they're running. And ultimately that's probably a good thing."
TFF doesn't agree and suggests that Salmon is wrong to link treasuries to the previously triple A rated mortgage backed securities which of course proved to have anything but a low risk.
He writes: "Felix, this proposal smells of a symbolic move more than anything else.
"If there's credit risk in triple-A bonds, it's too small to price or to worry about, and so, by convention, it's ignored."
"All risk is relative. The credit risk for AAA bonds need not be zero, it need only be less than the credit risk for AA bonds. If you truly wanted "zero-risk dollars" (an oxymoron on the face of it), wouldn't you hold physical greenbacks? Or the electronic equivalent on deposit with the Fed? The MBS disaster was another issue entirely. Those bonds were seriously *mis*-rated, and people unquestioningly accepted those ratings. Lazy people, charging millions of dollars for "managing" money that belongs to others."
DwJ is uncertain how the system could be changed. He writes: "If AA+ were the highest rating, would people start thinking of that as risk-free? Would introducing a AAA+ rating and refusing to bestow it on anything stop people from thinking of AAA as risk-free?"
Danny Black, echoing some of the sentiment from yesterday, believes that regulation and even the structure of capitalism is partly to blame though he cannot see how it could be unwound.
He writes: "For some reason you ignored the real reason AAA is so important and that is due to regulation. A significant portion of investors have severe limitations on what they can buy. They are not too lazy or overworked to look at other bonds, they usually cannot buy them hence the tranching and structured products business. For instance UK Pension funds did not think that a notional yield of 3.48% was a great punt for a 50 year gilt but because of the way pension fund liabilities were regulated, magically anyone who bought a 50 year gilt at ANY price who consider more solvent and better funded which reduced the amount the sponsors had to put into the fund. That is a real cash incentive for companies to do something stupid whilst knowing it is stupid.
"The ratings are written into virtually every single derivative contract, again due to regulation. Ratings are written in capital regulation. They are written into most loan covenants. All of which are positive feedback triggers waiting to send a company or country into a death spiral once they hit an arbitrary barrier. Due to their pervasiveness it is hard to see how they could be removed."
Of course it is not all about Treasuries. The Philidelphia Inquirer's Erin Arvedlund, featured here on Seeking Alpha, considers what might happen to municipal bonds, many of which are linked to the US's overall triple A rating.
And a couple of days ago the Wall Street Journal featured an interview with one of those who might downgrade the debt, Standard & Poor's David T. Beers. He told the paper: ""If you want your ratings to do what they are designed to do, you have to call these things as you see them. And that's what we are committed to doing."
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