Posted: September 29, 2011
Financial theatre of the absurd
S&P knocks us down, and the bond market goes bonkersBy Ron Phillips
We have all heard about the disastrous debt downgrade of our nation. But is it justified? This is a very heated topic that quickly becomes political. My vague answer is "yes" and "no." The downgrade makes sense, but I feel it is not entirely accurate.
Standard & Poor's has quite a bit of justification for lowering the rating. We have our highest national debt levels in history. We have the biggest future obligations in history. We have low tax revenue. We have weak and impotent political spirit. And on and on.
But is S&P the best judge of credit? I do not know the specific, complex process that credit agencies use but S&P does not have the best batting average. They very recently rated toxic mortgages as AAA, the very highest credit quality. We know how that turned out.
They also downgraded Berkshire Hathaway, Warren Buffett's holding company, from the pristine AAA, to the next lowest AA+ rating. Why did they downgrade Buffett? Mainly because he bought BNSF Railroad. About a year later the company's cash on hand is back up to over $40 billion and they own a profitable railroad. Berkshire looks stronger than ever, not suffering a credit crisis.
As a side note, Buffett very publicly said the U.S. deserves a quadruple-A credit rating. Maybe he is still sour over his downgrade....
The bottom line still remains. The U.S. is saddled with an unmanageable amount of current and future debt. And the trend is obviously moving upward. That is essentially why we were downgraded.
This vote of no confidence created an absurd result. The very debt that was knocked down was bought hand over fist. Treasury bonds recently sold for a 14 percent premium. For every $1,000 of bonds investors were shelling out $1,140 in cash to purchase them. At maturity, in 30 years, those bonds will only pay the $1,000 face value. A guaranteed loss of principle?
Why would anyone invest in that?
I think The Sage of Omaha was onto something. When there is panic in the markets, whether international or local, people usually flock to Treasury debt. U.S. bonds are the only investment that I, as a stockbroker and financial advisor, can legally call risk-free. That is because of the strength of our economy, our taxing power and because we have never defaulted on debt or interest. Maybe we should be AAAA-rated.
Ron Phillips is an Independent Financial Advisor and a Pueblo, Colorado native. He and his wife are currently raising their two sons in Pueblo. Order a free copy of his book "Investing To Win" by visiting www.RetireIQ.info or leaving a message on his prerecorded voicemail at 924-5070. Simply mention Promo Code #1001 when ordering.