Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Eiro-group Review –The power of trading education - 4th Dec 20
Early Investors set to win big as FDA fast-tracks this ancient medicine - 3rd Dec 20
New PC System Switch On, Where's Windows 10 Licence Key? Overclockers UK OEM Review (5) - 3rd Dec 20
Poundland Budget Christmas Decorations Shopping 2020 to Beat the Corona Economic Depression - 3rd Dec 20
What is the right type of insurance for you, and how do you find it? - 3rd Dec 20
What Are the 3 Stocks That Will Benefit from Covid-19? - 3rd Dec 20
Gold & the USDX: Correlations - 2nd Dec 20
How An Ancient Medicine Is Taking On The $16 Trillion Pharmaceutical Industry - 2nd Dec 20
Amazon Black Friday vs Prime Day vs Cyber Monday, Which are Real or Fake Sales - 1st Dec 20
The No.1 Biotech Stock for 2021 - 1st Dec 20
Stocks Bears Last Chance Before Market Rally To SPX 4200 In 2021 - 1st Dec 20
Globalists Poised for a “Great Reset” – Any Role for Gold? - 1st Dec 20
How to Get FREE REAL Christmas Tree 2020! Easy DIY Money Saving - 1st Dec 20
The Truth About “6G” - 30th Nov 20
Ancient Aztec Secret Could Lead To A $6.9 Billion Biotech Breakthrough - 30th Nov 20
AMD Ryzen Zen 3 NO UK MSRP Stock - 5600x, 5800x, 5900x 5950x Selling at DOUBLE FAKE MSRP Prices - 29th Nov 20
Stock Market Short-term Decision Time - 29th Nov 20
Look at These 2 Big Warning Signs for the U.S. Economy - 29th Nov 20
Dow Stock Market Short-term and Long-term Trend Analysis - 28th Nov 20
How To Spot The End Of An Excess Market Trend Phase – Part II - 28th Nov 20
The Gold Stocks Correction is Maturing - 28th Nov 20
Biden and Yellen Pushed Gold Price Down to $1,800 - 28th Nov 20
Sheffield Christmas Lights 2020 - Peace Gardens vs 2019 and 2018 - 28th Nov 20
MUST WATCH Before You Waste Money on Buying A New PC Computer System - 27th Nov 20
Gold: Insurance for Prudent Investors, Precious Metals Reduce Risk & Preserve Wealth - 27th Nov 20
How To Spot The End Of An Excess Market Trend Phase - 27th Nov 20
Snow Falling Effect Christmas Lights Outdoor Projector Amazon Review - 27th Nov 20
4 Reasons Why You Shouldn't Put off Your Roof Repairs - 27th Nov 20
Further Clues Reveal Gold’s Weakness - 26th Nov 20
Fun Things to Do this Christmas - 26th Nov 20
Industries that Require Secure Messaging Apps - 26th Nov 20
Dow Stock Market Trend Analysis - 25th Nov 20
Amazon Black Friday Dell 32 Inch S3220DGF VA Curved Screen Gaming Monitor Bargain Deal! - 25th Nov 20
Biden the Silver Bull - 25th Nov 20
Inflation Warning to the Fed: Be Careful What You Wish For - 25th Nov 20
Financial Stocks Sector ETF Shows Unique Island Setup – What Next? - 25th Nov 20
Herd Immunity or Herd Insolvency: Which Will Affect Gold More? - 25th Nov 20
Stock Market SEASONAL TREND and ELECTION CYCLE - 24th Nov 20
Amazon Black Friday - Karcher K7 FC Pressure Washer Assembly and 1st Use - Is it Any Good? - 24th Nov 20
I Dislike Shallow People And Shallow Market Pullbacks - 24th Nov 20
Small Traders vs. Large Traders vs. Commercials: Who Is Right Most Often? - 24th Nov 20
10 Reasons You Should Trade With a Regulated Broker In UK - 24th Nov 20
Stock Market Elliott Wave Analysis - 23rd Nov 20
Evolution of the Fed - 23rd Nov 20
Gold and Silver Now and Then - A Comparison - 23rd Nov 20
Nasdaq NQ Has Stalled Above a 1.382 Fibonacci Expansion Range Three Times - 23rd Nov 20
Learn How To Trade Forex Successfully - 23rd Nov 20
Market 2020 vs 2016 and 2012 - 22nd Nov 20
Gold & Silver - Adapting Dynamic Learning Shows Possible Upside Price Rally - 22nd Nov 20
Stock Market Short-term Correction - 22nd Nov 20
Stock Market SPY/SPX Island Setups Warn Of A Potential Reversal In This Uptrend - 21st Nov 20
Why Budgies Make Great Pets for Kids - 21st Nov 20
How To Find The Best Dry Dog Food For Your Furry Best Friend?  - 21st Nov 20
The Key to a Successful LGBT Relationship is Matching by Preferences - 21st Nov 20
Stock Market Dow Long-term Trend Analysis - 20th Nov 20
Margin: How Stock Market Investors Are "Reaching for the Stars" - 20th Nov 20
World’s Largest Free-Trade Pact Inspiration for Global Economic Recovery - 20th Nov 20
Dating Sites Break all the Stereotypes About Distance - 20th Nov 20

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

USA AAA Credit Rating in Label Only

Politics / US Debt Jul 29, 2011 - 07:34 AM GMT

By: Janet_Tavakoli


Best Financial Markets Analysis ArticleSovereigns that bailed out banks are saddled with much greater government debt than before the crisis. In the spring of 2007, the Fed and the U.K.'s FSA reported that the degree of leverage in the global financial system was less than at the time of Long Term Capital Management, but in reality it was much greater. Global regulators are now repeating their mistakes. The risks in the interconnected global banking system have moved to currency trading and currency derivatives (remember the contribution of knock-in options to the 1995 currency crisis), leveraged loans, credit derivatives, market-linked derivatives, speculation in commodities, and both foreign and domestic government debt. Winston Churchill said we must alert somnolent authority to novel dangers; but our regulators are complacent, and the dangers are not novel.

With respect to the recent crisis, highly leveraged fixed income assets posed perils to the global banking system. When excessive leverage is combined with fixed income assets acquired at par, there is extreme risk. If the assets decline in value and liquidity becomes tight, it can cause a vicious cycle of selling that feeds on itself. If one combines that with foreign currency risk, one adds to the potential pain. If that is further accompanied by a price reduction that is due to a permanent or at least sustained price decline in underlying assets, it is virtually impossible for an undercapitalized overleveraged entity to recover from even a temporary liquidity shock. If a country cannot quickly refinance (roll financing), the collapse is quick and brutal. This isn't a new discovery, this is simply a fact.

The structured component of international finance is so influential that the failure of the rating "agencies" (which aren't agencies at all; they're private companies) to competently rate structured financial products -- and their overall incompetence with derivatives -- means that their sovereign ratings are largely meaningless. The various issues with Portugal, Ireland, Italy, Greece and Spain (the PIIGS) are beyond the scope of this report, but the rating agencies, already at sea, seem to be somewhat influenced by politics as downgrades lagged and in some cases continue to lag reality. The result is that ratings adjustments come long after the need for a downgrade is obvious. To be clear, this has nothing to do with the theory of efficient markets. The rating agencies seem to flounder and arrive late to the party.

Banks that engaged in leveraged borrowing and that trade derivatives including currency derivatives, credit derivatives, commodity derivatives, and interest rate derivatives are not within the ability of the rating agencies to competently rate. Since governments' and central banks' finances are intimately tied with the global banking system, the rating agencies do not competently rate sovereign debt.

Sovereign Rating Example: Iceland's "Aaa"

Moody's misguided "Aaa" ratings (unlike S&P, Moody's uses "Aaa" to denote "AAA") were not limited to securitizations. In 2007, financial professionals derided Iceland's inflated "Aaa" rating due to the risk posed by excessive leverage and excessive borrowing in foreign currencies. A cult YouTube video, apparently out of Bombay, India in 2007 mocked Moody's and its "Aaa" Iceland rating. It was widely circulated among financial professionals.

Moody's tried to temper its decision in a January 2008 report: "Iceland's Aaa Ratings at a Crossroads." It wrote: "Iceland enjoys high per capita incomes, well-developed political, economic and social institutions, favorable demographics and a fully-funded public pension system... Its government debt ratio is less than half the average of the Eurozone member countries." Moody's did all it could to rationalize its decision to maintain the "Aaa" rating.

As was true of many of Moody's "Aaa" ratings, it was forced to give up the game. In October 2008, Iceland temporarily suspended stock trading and seized Kaupthing, the country's largest bank, as its banking system collapsed and plunged the country into bankruptcy. Iceland's external debt was around $70 billion at current exchange rates (then €50 billion) or around $218,000 for each of its 320,000 citizens.

United States: "AAA" in Label Only

The financial debacle was enabled by a classic control fraud within our largest banks. Wall Street's huge bonus payments were based on suspect accounting, and bankers continue to seek those rewards by ramping up risk within the banks. Many banks' current illusion of profitability is currently only made possible by taxpayers' enormous subsidies including low cost borrowing, higher interest payments on bank capital deposits, a credit line for the FDIC (to be repaid with banks' subsidized profits), and continued government debt guarantees on bank debt. A large share of certain banks' tax-subsidized profits is due as reparation to unsophisticated investors, the U.S. taxpayers. While the Fed prints money, it seeks to keep short-term interest rates artificially low, essentially robbing investors who earn such low interest rates on "safe" investments, that after inflation, they are earning negative real returns.

The Fed uses tax dollars to keep some of our largest banks -- weakened by reverse-Glass-Steagall mergers with troubled entities -- from collapsing under heavy loan losses. U.S. taxpayers became unwilling unsophisticated investors funding Wall Street's bailout.

In the wake of the global financial crisis, Bloomberg estimated that by March 21, 2009, pledges by the Federal Reserve, Treasury Department, Federal Deposit Insurance Corporation topped $12.8 trillion. The U.S. GDP was $14.2 trillion. At the time the pledges represented more than $42,000 for every man, woman and child in the U.S.

Massive hiding-in-plain-sight fraud damaged the U.S. economy. Housing prices didn't just fall; they plummeted as the fraud unraveled. By the end of 2010, four million home loans were more than 50% underwater with an average of $107,000 negative equity; this alone is around $428 billion in negative equity. 7.8 million loans were 25% or more underwater. Most of these damaged borrowers were paying higher interest rates than the national average, couldn't refinance, and were ineligible for HAMP, a government initiated refinancing program.

Securitized assets were dumped on the balance sheets of the Fed (and the Fed supplied near zero cost funding to plug holes in bank balance sheets and special government guarantees on bank debt), special purpose entities set up by the Fed, Fannie Mae, Freddie Mac, and the FHA (through government guarantees). Government guarantees allowed for new issuance of securitized mortgage loans that otherwise would have no buyers, since the rating agencies are widely mistrusted.

The effect of existing government entitlements and obligations combined with expanding bank debt, flawed loans, flawed securitizations, and leverage significantly weakened the U.S. economy stunting growth as money was diverted to the banks and away from capital spending, the biggest driver of any economy.

The damage of financial malfeasance was so extensive and the protocol of the bailout so profligate that the "AAA" rating of the United States has been rendered an incorrect but politically expedient label. The U.S. issues its debt in dollars, and if necessary can engage in a silent default by devaluing the U.S. dollar. To some extent, that has already happened.

The U.S. dollar is still the world's reserve currency. It is also an "intervention" currency, and an "invoice" currency for much international trade. Central banks hold dollars as a reserve, and private agents hold dollar denominated investments. So far, the U.S. has the most well developed short-term financial markets, so when there is a "flight to quality," which these days means the lessor of other evils, foreigners rush to liquid financial instruments like T-Bills.

Unlike the Yuan, the U.S. dollar is freely exchangeable in most of the world. The U.S. buys its major imports such as oil in dollars. But change is already in process. Iran has said it will accept Yuan for oil. There is talk of oil prices being expressed in a basket of currencies that will include gold. Gold is already being accepted as collateral on derivatives exchanges, and in this sense, gold is now recognized again as money for trading purposes.

The problem for the U.S. is that despite the temporary advantages, the world is diversifying into other currencies, including gold. The Yen and Deutsche Mark (before the Euro) were the former candidates for diversification. Future candidates may be the Yuan and perhaps a new Euro (if Germany prevails in getting its way). That will push up the value of those currencies and push down the value of the dollar.

Even if this doesn't happen right away, the U.S. is in a weakened state and it is not immune to shocks. Recall the 1973 oil embargo, for example. Oil prices quadrupled overnight and the dollar fell from 350 yen to 250 and from 3.25 Swiss francs to 1.80. Two hour moves eclipsed the previous two decades. Then there was the 1995 U.S. dollar crisis brought about by the "tequila effect" when one of our debtors, Mexico, neared default and had to be bailed out.

When foreigners lose confidence in the United States, they don't suddenly sell all of their assets or pull out all of their money (although some of that does happen), the immediate effect is a fast fall in the dollar. The Fed has compensated for the explosion in new debt by purchasing government bonds, but this strategy may not be sustainable, and if not, there may be a swift rise in interest rates.

The current "AAA" rating of the United States is not on merit, but it is a convenient fiction for the global financial markets, because no one yet has an alternative. It would be more accurate to say that the United States remains investment grade, because of our current role in the infrastructure of the global economy. Whether or not the rating agencies put an explicit downgrade on the United States is largely irrelevant. The United States has seen huge U.S. dollar fluctuations and higher interest rates in the past, and on its current course will see them again. The fundamentals of the U.S.'s increasing debt load, massive future entitlements, high unemployment rate, and weak economy with no meaningful growth plan speak for themselves.

This commentary has been excerpted from, "Tavakoli Structured Finance Revokes the Credit Rating Agencies' NRSRO Designation: Issues and Solutions for Restoring Credibility to the Credit Rating Agencies and Rehabilitating the Alternative Banking System," July 26, 2011.

Charity auction bidding ends Monday, August 1 at 7:30 PM PDT for "Lunch with Janet Tavakoli at Michael's in New York to Benefit Safe Haven Alliance" (Save Abandoned Babies). Michael's restaurant in New York is contributing the meals for the bidder and three friends to lunch with Janet. Click here to bid or view bidding results.

By Janet Tavakoli

web site:

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

© 2011 Copyright Janet Tavakoli- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules