Would a U.S. Downgrade Really Be That Bad?: The Ticker

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By Francis Wilkinson

While many Americans brace for a downgrade of U.S. debt, Congress's Tea Party contingent is not alone in questioning whether things might not be all that bad. In the Financial Times this week, LEX raised the possibility of "an ironic twist" in the event of a ratings downgrade, with investors fleeing to safety by investing in  . . .  more U.S debt:

"A US downgrade might cause Treasuries to rally as riskier assets were dropped. A bet against the richest and most powerful country on the planet is never a safe one."

Mark Gongloff in the Wall Street Journal's Market Beat blog had similar thoughts:

"The reality is that US Treasuries, federally guaranteed mortgage-backed securities and agency debt account for 53 percent of all triple-A assets in the global bond universe, according to Nomura. There are few other places to go."

Gongloff cites a BMO Capital Markets analysis stating that:

"Ten years have passed since Japan lost its AAA rating and while its 10-year yield still remains close to 1% its currency has not been negatively impacted, but rather it is near the strongest levels of the decade.

Therefore while a credit downgrade would create a long period of uncertainty before all the implications became clear, there is precedent to suggest that rates may not spike higher as some market participants are expecting and the world’s reserve currency may remain unaffected."

University of California-Berkeley economist, blogger (and Bloomberg View op-ed contributor) Brad DeLong says those shrugging at a downgrade may be right, but when you're traveling to distant galaxies with a terrestrial map, there's no telling where you'll end up:

"The fact is that nobody knows what will happen to the Ten-Year Treasury yield if S&P downgrades the U.S. credit rating.

1. The interest rate on the Ten-Year Treasury bond could spike.

2. The interest rate on the bond could even fall -- more chaos means a weaker global economy, and in a weaker global economy in the absence of inflation you should be holding more U.S. Treasury bonds, not fewer.

3. The interest rate on the bond could stay where it is, as the two types of fear offset each other.

4. The interest rate on the bond could stay where it is as markets laugh at S&P's chutzpah, at the institution that claimed that MBSs were safe now claims that U.S. Treasuries are risky.

5. Demand for U.S. Treasuries could fall, but the yield could stay the same as some other large actor -- the People's Bank of China or the Federal Reserve -- steps in and buys long-term Treasury bonds in order to stabilize the market.

I have talked over the past two weeks to at least one investor with substantial positions who himself is confident that each of these is the likely possibility.

The future is wide open.

Uncertainty is massive."

While granting several universes full of Rumsfeldian known unknowns, Bloomberg Businessweek contributor Annie Lowrey of Slate nonetheless insists that some aspects of this manufactured crisis are clearly understood.

"Nobody really knows what would happen.  . . .  But we know its risk: a recession," she writes. "And we know how we got here: idiots."

Of the varied analyses on offer this week, that one seems destined to stand the test of time.

-0- Jul/29/2011 19:32 GMT