About the Author: PKamp3 is a writer at Don’t Quit Your Day Job, a web site which explores the intersection of economics, politics, investing, personal finance and the offbeat.

It’s déjà vu all over again as the financial press mulls over the effects of a second firm lowering the debt of the United States.  If you recall, back on August 6th, S&P lowered the debt rating of the United States to AA+ from their prestigious AAA.  Far from the apocalypse some financial and political writers predicted, the cost of 10 year debt in the United States has actually come down from 2.58% on August 5th to 2.34% as of October 28.  Funny how that works… investors fled the debt of the United States and sought safety in… the debt of the United States.

When a Rating Isn’t a Score

Luckily for the United States (and other large ) credit ratings don’t matter much. The truth is, the United States isn’t like you or me.  Huge entities like the United States have open fiscal books and loads of economic indicators tracking every nuance of their economy.  While credit ratings make sense for individuals, some companies, and even smaller municipalities, they are just another thread in an endless tapestry for the huge borrowers we are considering.  Even if S&P, Moody’s, and Fitch all stop rating the debt of the United States tomorrow investors will still be able to accurately price whatever debt the US issues.  For gigantic borrowers like countries, the most important metric isn’t the declared debt rating of some company.  It’s yield.

Here’s how the United States stacks up against all of the countries which the S&P AAA, AA+, AA, or AA-. Remember, the United states is an AA+. For my sources (and a list of entities left out and why) please see the spreadsheet I compiled. I’m using 10 year debt as my benchmark.

How to Play It

Even though a credit rating is a measurement of a country’s ability to pay back debt, it was actually the market which experienced the most volatility post ratings cut.  On August 3rd, the closed at a healthy level of 1,260.34.  On the 8th, the first trading day after the ratings cut, it closed at 1,119.46… down 11.2% in just a few days.  On Friday?  It closed at 1,285.09.  Perhaps the investors in the audience should consider any further rating cuts an investment opportunity?

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  3 Responses to “Easy A: Debt Ratings Don’t Matter, Yields Do”

  1. I couldn’t agree more. I have to question the relevance of the ratings agencies, though. There seems to be a bit more wrong ratings than right ones lately. The most recent being MF Global initially getting a higher rating than it should have.

    • The interesting thing about rating agencies is how hard-wired in they are to the entire financial system. The regulators were basically forced to abandon the idea of getting rid of them because 1) There is no better solution out there 2) who is going to pay for a new solution or the ratings, not investors I can tell that and 3) removing the ratings-based triggers and covenants from all of the millions of credit, trading and legal agreements would be a total nightmare.

      The bottomline is that whether we like it or not, given the current form of the financial system we need rating agencies, otherwise we’ve got nothing! Imagine if investors didn’t even have the rating agencies? Like I said, interesting.

  2. It’s strange how these credit ratings work differently for countries compared to individuals, as an idividual the more debt you have the higher your credit rating and the more the banks want to throw money at you ! promo gifts

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