This credit rating a companies, however, more often is used on private sector entities that issue debt instruments like bonds and equity shares. The private investors on privately issued debt instruments and equity shares put a heavy weight on the ratings issued by the three credit raters. Seldom if ever do they use the ratings on government bonds, most particularly on the United States bonds issued by the government. Government bond issues considered riskless. As such, they used as benchmark in the evaluation of the potential rate of return of a bond issue or equity shares.
Since 1917, the United States Federal government credit ratings have never downgraded because it is riskless and have never defaulted on its debt payments. It is sad that suddenly one of the credit rating companies took the bold step to downgrade the US government credit rating. Fortunately, this assessment is not unanimous among the three credit raters. It would be a different story if all three had the same conclusion on the Federal Government credit rating.
Standard and poor downgraded the credit rating. I do not agree on such an assessment and decision. The downgraded would indeed create a ripple in the bond market but this is not absolute right. Rating a company or of the government of the United States depends on many factors. While it may be possible and the possibility does exist because of the growing fiscal budget deficits, it is not yet certain that the government will default. At best, this is more a speculation.
Fortunately, the market prices on government bonds in the bond market have not declined. The buyers virtually ignored the S & P’s downgrading. The indication however is that the bond market may move toward a bearish market (Ciovacco, 2011).
Risks in Downgrading of Credit Rating
The risks in the downgrading is when the market responses immediately and accept the S & Ps downgraded. The greater risks are the effect of the credit image of the United States as an economic power in the world. The recession has already started as indications clearly show on the increasing unemployment, low production and demand.
If the market accepts the lower rating it means that, the sale of government debt instruments will be more difficult. In fact the reserves of banks which are mostly government debt issues means that these are going to be inadequate by the lower market prices of the bonds from their original price when these were purchased and kept a s a reserve.
Foreign investors may shy away from investing in the United States. This will further deplete the economy’s major source of funds for investments in local capital (Moneycontrol.com, 2011).
The institutional investors that are adverse to negative news on securities that they hold, particularly the pension fund trustees may unload their bond holdings.
The additional risks is the possibility of a currency rate change either by the market in view of the effect of the Euro dollar vis-à-vis the US dollar, or by mere operation of law when the government, at the extreme case, sets a lower rate of exchange on its currency compared to the related currency.
References
Ciovacco, C. (2011). How a downgrade of U.S. debt will impact stock and bond prices. Retrieved from http://seekingalpha.com/article/282227-how-a-downgrade-of-u-s-debt-will-impact-stock-and-bond-prices
Moneycontrol.com. (2011). Expert views: How will US downgrade impact global markets. Retrieved from http://www.moneycontrol.com/news/world-news/expert-views-how-will-us-downgrade-impact-global-markets-_573695.html
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