Triple-A Rescue

No, this is not about emergency road rescues. This is about the American government’s future ability to repay its debt... you know, those US Treasuries you hold in your investment portfolio.

Moody’s, an agency that ranks countries according to their capacity (and willingness) to repay their debt, said yesterday the US government could lose first-class rating due to pressures on its finances from the rising costs of the Medicare and Medicaid programs.

Moody’s rankings (or “credit ratings," to throw in some indispensable party jargon) come in the form of letters: A, B, C and so on, and combinations thereof. Triple-A (Aaa) types are the top of the class, and the American government shares that front row with Germany, France, the UK and Canada among others.

At the other end of the spectrum you have the B’s and C’s—or “Basket Cases”. These are the likes of Argentina, Belize, Lebanon or Ecuador, who are either about to go bust, or have gone bust multiple times in the past, or who have “promised” to go bust because, in some parts of the world, screwing up investors scores political points.

So what’s the big deal with a teeny downgrade to “double A” (Aa)? We are still A-types, aren’t we? Well, pretty big actually. And not just because we would now go back a row to sit with the likes of Belgium, Kuwait and Macao!

US Treasuries, which are short-term debt obligations of the US government, are considered the world over to be “risk-free.” Rain or shine, you always get your money back, plus interest—the “risk-free rate.” Nobody expects the US government to default on its debt. As such, the interest rate paid by US Treasuries sets the benchmark for the interest rate paid by riskier borrowers, from Argentina, to Walmart, to you and your mortgage.

Now this is big. Aa doesn't sound as risk-free as Aaa, so you can imagine the chaos of trying to find another benchmark for pricing the millions of investment instruments out there.

And then there are your investments. When a borrower, be it the government of Argentina or mortgage issuer Countrywide, has its credit rating downgraded, this tends to lower the price of the bonds they issue. This makes sense. The more of a basket case you are, the cheaper it should be for me to buy your bonds. Put it in plainer terms, if you are a triple-A, I could lend you today $97 and require that you pay me $100 in a year from now. Making a respectable 3 percent interest. But if you suddenly get Aa, rest assured I’ll ask for more.. I’d lend you, say, $96 for the $100 that you’ll give me in a year from now!

Now, what would happen if all those who hold US government debt, from you and me, to Japanese housewives, to the likes of China or Saudi Arabia, dumped their trillions of US debt securities out of fear of price falls because of a future downgrade? Yes, that's right, a downward spiral in the value of your investments.

To be fair, one would realistically expect that Moody’s concerns over America’s public finances will be resolved, at least partially, way before a downgrade occurs. After all, it’s not the first time that the agency cries wolf!

But it wouldn’t really harm if you actually did something about it… Like, demand from your elected representatives a meaningful and sustainable solution to the healthcare situation. Try it… it’s risk-free!

Glossary: US Treasuries, credit-rating, triple-A, risk-free rate, basket case.