A Financial Atom Bomb
by Martin D. Weiss Ph.D
Posted originally April 25, 2011
NEARLY A YEAR AGO, I PUBLICLY CHALLENGED S&P, MOODY’S AND FITCH to downgrade the long-term debt of the United States government — to help protect investors and prod Washington to fix its finances. In a moment, I’ll show you why their failure to respond is ripping off investors, how it’s exposing millions to a financial atom bomb, and what you can do for immediate fallout protection.
But first, this question: Did S&P finally respond to my challenge last week when it “downgraded” U.S. debt to “negative”? To the casual observer, that might appear to be the case. But in reality, their action — much like recent steps by Washington to “fix” the deficit — was little more than smoke and mirrors. Here are the facts:
• S&P did NOT change, even by one tiny notch, its “AAA” rating for U.S. government debt. It merely changed its future “outlook” for the rating.
• S&P did NOT have the courage to do what’s right for investors and for the country today. It merely said it might do something a couple of years from now.
• Worst of all, S&P has done nothing to change its practices that have caused so much pain for investors in recent years. As before, it’s typically quick to upgrade its best-paying clients, but often delays meaningful downgrades until it’s far too late.
It’s the greatest financial scandal of our time, and the U.S. Government’s Triple-A rating is the most scandalous of all.
• In proportion to the size of its economy, the U.S. government has bigger deficits, more debt, plus bigger future liabilities to Medicare and Social Security than many countries receiving far lower ratings from S&P, Moody’s and Fitch.
• Compared to lower rated countries, the U.S. also has a greater reliance on foreign financing, a weaker currency, and far smaller international reserves.
• The U.S. government is exposed to trillions of dollars in contingent liabilities from its intervention on behalf of financial institutions during the 2008-2009 debt crisis.
• The U.S. Federal Reserve, as part of its response to the financial crisis, may be exposed to significant credit risk.
• The U.S. economy is heavily indebted at all levels, despite recent deleveraging.
• U.S. states and municipalities are experiencing severe economic distress and may require intervention from the federal government.
• The U.S government’s finances could be [will be!] adversely impacted by a rise in interest rates.
• The U.S. dollar may not continue to enjoy reserve currency status and may continue to decline.
• Improper payments by the federal government continue to increase despite the Improper Payments Information Act of 2002.
• The U.S. government had failed its official audit by the Government Accountability Office (GAO) for 14 years in a row, with 31 material weaknesses found in 24 government departments and agencies.
This is no secret. Nor am I citing original facts. They are the same facts that have been written about extensively by Jim Grant, editor of the Interest Rate Observer, brought to light by the U.S. Government Accountability Office and widely publicized by its former chief, David Walker. They are similar to the points made in recent warnings by the International Monetary Fund, the Congressional Budget Office, the European Central Bank, the president’s deficit commission, and even the Big Three Rating agencies themselves.
And yet, the U.S. government STILL gets a AAA rating from all three? And all the while, other countries, which do NOT have these problems, get far lower grades? This doesn’t even pass a simple smell test. It reeks of egregious conflicts of interest. We know that the Big Three rating agencies failed to warn investors about giant insurers that went bankrupt in the early 1990s. We also know how they bungled their ratings of Enron in 2001 and gave stellar grades to big Wall Street firms that failed in 2008. So it’s fair to suspect that similar problems afflict their sovereign debt ratings.
If the Big Three rating agencies downgraded the debt of the United States government, they would come under tremendous pressure to ALSO downgrade big borrowers that count on the U.S. government for sponsorship, financing or bailouts. But those big borrowers PAY the rating agencies huge yearly fees for their ratings and would be less willing — or even less able — to continue those payments if their debts are downgraded.
Why you’re getting ripped off (and worse!)
If you think this fundamental dishonesty doesn’t impact you directly, think again. Even if there are no further consequences, you’ve already paid a high price for it: The rating agencies are understating the risk of your investments, and consequently, those investments are paying you LESS yield than you deserve to compensate you for the real risk you’re taking.
This is true not only for U.S. Treasury securities, but also for virtually every bond ever issued. If the U.S. Treasury itself were graded at its appropriate level, thousands of other securities, traditionally assumed to be of lower quality than Treasuries, would need to be seriously reviewed for parallel downgrades. But until that review takes place, many get away with paying you less interest than you deserve. You’re also not getting a fair interest rate on bank CDs or insurance policies.
Nor is this impact limited to fixed instruments. If bonds are downgraded and must pay higher yields, nearly every other investment in the world would be pressured to do the same. That’s why this is a financial atom bomb. And that’s why it’s shameless. If the rating agencies had rated U.S. debt honestly years ago, we might not be in this predicament.
What’s worse is that:
- Treasury note and bond investors are exposed to far greater risks than they’re being told about. Even assuming the U.S. government never defaults, you can lose a lot of money from declining market values of notes and bonds, from the declining purchasing power of your dollars, or both …
- Citizens and residents of the U.S. are exposed to far greater risk of rising taxes and slashed benefits payments than is implied in the triple-A ratings, and, alas …
- Our entire country and way of life is in far greater danger than Washington or Wall Street would have you believe.
With each day that passes, investors in the U.S. and overseas will gain greater clarity of vision, smell the dangers, and begin to recognize that the emperor has no clothes. They will respond by taking action, driving U.S. bond prices and the U.S. dollar sharply lower. You need to take protective steps AHEAD of time.
First and foremost, sell any Treasury notes and bonds that you may still be holding — either directly or via a fund. Bonds (defined as 10 to 30 years) are the riskiest. Notes (one to 10 years) are also subject to declines, especially in the longer maturities. And bills (under one year) are the least risky. Second, for protection against falling bond prices, Weiss Research’s Mike Larson recommends inverse Treasury ETFs like TBT — a fund that’s designed to go up 2% when Treasury bond prices fall by 1%. Third, for protection against a falling dollar, consider ETFs that buy exclusively the strongest foreign currencies like the Australian dollar and Brazilian ETF. Fourth, to hedge against inflation, gold ETFs like GLD are among the simplest solutions. [Bullion best of all!]
And above all, stay SAFE! Good luck and God bless!