Downgrading America

| Fri Jan. 28, 2011 2:45 PM EST

Karl Smith on the possibility that ratings agencies will downgrade U.S. debt from its current AAA rating:

I am [] willing to take 50 to 1 odds that President Obama doesn’t understand what a downgrading of US Treasuries would mean. He could probably trot out some line about investor confidence but what this actually meant and the significance or more to the point, lack thereof, he would not be able to explain cogently.

I can't speak for Obama, but I have a feeling that the significance would be: zero. Granted, there's symbolic importance to something like this, and on a substantive level there are certain funds that are legally prohibited from holding non-AAA debt. So fine: maybe not quite zero.

But U.S. debt is simply too big, too public, and too widely followed for ratings agencies to have much influence over it. Everyone knows what the problems with the American economy are, and no one thinks that the folks at Moody's or S&P know any more about it than anyone else. They just don't have any special expertise to offer here. A downgrade might provide an opportunity for some short-term arbitrage, but beyond that it's not clear if it would have any effect at all. It's the market that determines the price of U.S. debt, not the ratings agencies.

(The president couldn't actually say anything this cavalier, of course. He'd have to trot out some line about investor confidence and the long-term strength of the U.S. economy blah blah blah. Still, I think zero is more or less the actual correct answer.)