[longrema]

Washington Post: http://www.washingtonpost.com/blogs/...NKxI_blog.html

Why it might matter: If the U.S. debt gets downgraded, many other debt instruments will likely get downgraded as well. When Moody’s put U.S. debt on review for downgrade during the debt ceiling standoff, if also put on notice 7,000 other bonds, worth a total of $130 billion, that rely directly on revenue from federal government payments, such as certain kinds of municipal bonds. Bonds that are indirectly dependent on the federal government, such as those issued by hospitals that receive Medicare payments, or defense firms reliant on Pentagon contracts, could get downgraded as well. In addition, many everyday interest rates - such as those for mortgages, car loans, and credit cards - are pegged to US Treasuries, meaning that if a downgrade forces up interest rates on US debt (which is likely, but will depend on how the markets react) interest rates for those will shoot up as well. This would raise the cost of borrowing across the system, depressing the economy.

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Additionally, many institutional investors — such as pension or money market funds — are required to hold a certain amount of AAA debt, meaning that some might be forced to sell off U.S. debt in the event of a downgrade. Given that money market funds hold about $338 billion in U.S. debt, or almost half of short-term holdings, this would be an enormous selloff, which would raise interest rates still higher and greatly amplify the economic damage incurred due to a downgrade.

Why It Might Not: Ratings are generally used as a proxy to determine the financial health of entities that investors may not know much about. But everyone knows about the health of the U.S. government, and now that the debt ceiling debate has passed no one thinks it is going to default any time soon. Thus, investors that might normally be inclined to not buy or keep AA-rated debt could make an exception for U.S. Treasuries. Indeed, some pension and money market funds have considered loosening their rules around debt ratings to allow higher holdings of U.S. debt in the event of a downgrade. Further, AA is still a very high rating. AA firms have statistically identical performance to AAA ones, according to the Fitch rating agency. Just this past January, S&P downgraded Japan’s debt from AA- to AA, and markets more or less didn’t care.