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Allen Gilmer

Allen Gilmer

Allen writes the popular energy news blog Open Choke

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What the S&P Downgrade Means to you and Me

S&P lowered the US debt rating from AAA to AA+ on Thursday.  What does this mean to you and me? Well, S&P is only one of three debt rating services, and the other two have said they aren't going to downgrade, but this is historic, nonetheless.

When your debt grade goes down, your cost of borrowing goes up.  This sad fact is NOT lambasted when you are a basic middle class person. It is made out to be the crime of the century when applied to "the poor" by the socioeconomic class divide and conquer folk. It means we have too much debt to handle safely.

Applied at the personal level... that bad credit folk either can't get a bank to loan them money or that they are charged higher rates to make up the risk of default. When we do stupid things out of feeling sorry for bad risk folks, like guaranteeing their payments, we typically end up... making their payments. 

So the cost of Fed Money is going to go up some amount. Since the Fed is the source of all funds, this means that interest rates at banks will go up, mortgage interest rates will go up, and the general cost of borrowing money will go up.

As a result, the value of homes, and businesses, and the stock equity values, and anything you use credit to buy will go down. Why? Because the cost to buy just went up, without any underlying change of value.

Let's take a house, for instance. If you can afford $1000 bucks a month for a payment, minus all the taxes and insurance and stuff, then the value of the house you can afford at 1% interest rate is is $311,000.00.  At 5% interest rate, that value drops to $186,000.00.  Poof.  $125,000.00, or nearly 40% of your value disappears automatically.  To be fair, your house probably wouldn't lose this total value, but the buyer pool would be substantially lower for your house now, because the cost to own it would be much higher, so the price will drop substantially.  It works exactly the same way for the Stock Market.  Cost to borrow goes up, equity value goes down. Simple as that. It is a Natural Law.  That's why the stock markets will behave negatively, although, to be fair, the market anticipated this downgrade, and the real result come monday may not be a drastic drop.  Had S&P said that it was satisfied with government efforts, then the stock market would have tended to rally, since the downgrade was so much baked it. 


So... we will see more downward pressure on home values. Downward pressure on stocks (meaning YOUR pension/401k/mutual funds).  Lower job growth. The whole gig.  To add to it all, the price of managing US debt just went up!  We get Jack Sh** for that extra expenditure, an expenditure we ship overseas to countries that do us a favor of loaning us money.

The S&P said that it had no confidence in our politicians to actually perform on its commitments it just made to reduce spending.  It also negatively noted that the US did not raise taxes. Why would it make that distinction?  Let me tell you...

Debt is caused by "Spending Too Much".  You spend more than you take in.  Responsible people and governments don't do this.  Why would you?  People with too much debt essentially want too many things that they can't afford.  Heartless as it may seem, too much debt is, 90+% of the time, the fault and responsibility of the person who decided to buy something they couldn't afford.  That trip to Cancun or that new Beemer on easy payments sure looks different after the fact.  It doesn't matter where you are on the socioeconomic ladder.   This problem is endemic. 

Once you get used to a certain level of spending, it is hard to reduce it.  Losing the BMW, foregoing the trip to Cancun... it's just not FAIR!  However, getting out of debt, for most of us, entails stopping spending.  The 2nd job can accelerate it, but it doesn't solve the problem.  You just die earlier.  Think of taxes as "The Second Job".

The S&P cited taxes because raising taxes is the LEAST politically risky action on Earth.  Less than 50% of us pay income taxes at all, and the ones they are targeting comprise the 2% of the 135 million tax returns filed reported income at this level.  Choosing to tax these folks isn't politically risky in the least, is it?  They only comprise 2% of the voters!  Most Americans believe in letting the richer guy tote the note, just not me. Stopping spending.... now THAT takes real political huevos!  We have lots of quivering lips around the myriad of government teats.  In fact, it seems the goal of our political class has been to gain a voter majority by giving them yours and my money (assuming you, dear reader, is a taxpayer).  The S&P guys know this. 


The government is no different than you or I.  Here is the perfect analogy to our current system... You own a home.  Over the years, you have allowed people to live in your home because they were "down on their luck". This group has trouble getting or holding jobs.  They are eating more and buying more things with your credit card, and they invite their friends to live in your house.  When you finally say "enough", they say it is only appropriate for you to go out and get a second job.  There are a lot of mouths to feed.  You are an insensitive uncaring individual for not getting the second job, all the while they are opening new credit accounts under your name.   And then they hold a vote, and they choose to keep on spending your money and for you to go out and get another job, deadbeat.  Its for the children.

In closing, my little nephew was showing me the money he had saved this morning.  I took 40% of it and put it in my pocket saying it was a tax, and that I would give it the less fortunate, minus a 60% carrying charge for my time in doing so.  What did he think of that?  He told me "that's crazy"!

By. Allen Gilmer

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Leave a comment
  • Anonymous on August 08 2011 said:
    Too bad not enough people will read this and still rely on the government to pay their debt.
  • Anonymous on August 09 2011 said:
    Larry Summers said that there is something wrong with S&P's arithmetic, and that is good enough for me. I think that they could have given the home team a 'pass' this time.As for the article, some of it makes economic sense: the effect of this downgrading on interest rates could be excruciating. What the author did not say is that we can thank George W. Bush for just about all of our troubles, and unfortunately Mr Obama did not have enough intelligence to do something about them.

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