Special Report: Markets Struggle with More Downgrades

Aug 8, 2011

In the wake of the recent historic news, JLN is putting out this Special Report to highlight some of the top stories from our newsletters.

Obama to make statement at 1 p.m. Eastern
Robert Schroeder – MarketWatch
WASHINGTON – President Barack Obama will make a statement to the press at 1 p.m. Eastern, the White House said Monday. The previously unscheduled statement comes as U.S. markets are reeling following the downgrade of the U.S. debt rating late Friday by Standard & Poor’s.

Special Report Stories:
S&P Cuts Ratings Of Major US Clearinghouses
CME Clearing is Not Planning to Adjust Haircuts Following S&P Rating Change to…
S&P Lowers Fannie, Freddie Citing Reliance on U.S. Government
Despite pledges from world leaders, global markets continue to fall
Gold Tops $1,700 for First Time on U.S. Rating
G-7 Seeks to Calm Investor Fear After World Stock Selloff

Lead Stories

S&P Cuts Ratings Of Major US Clearinghouses 
Jacob Bunge and Melodie Warner – DOW JONES NEWSWIRES
Standard & Poor’s Ratings Services cut ratings on the top U.S. financial clearinghouses Monday, as ripple effects from the firm’s historic downgrade of U.S. credit spread.
S&P lowered ratings on clearing facilities run by the Depository Trust & Clearing Corp. and OCC, previously known as the Options Clearing Corp., to double-A-plus, one step below the coveted triple-A rating, with negative outlooks.

Press Release
Standard & Poor’s has continued its lockstep approach of linking the ratings of a number of financial institutions and instruments to its rating of U.S. sovereign debt. Following the downgrade of U.S. sovereign debt to AA+ on Friday, S&P has now downgraded OCC, The Depository Trust Co. (DTC), National Securities Clearing Corp. (NSCC), and Fixed Income Clearing Corp. (FICC) to AA+ today.
“This rating change will have no negative impact on OCC’s operations or our ability to meet our obligations to OCC’s clearing members,” said Wayne P. Luthringshausen, OCC Chairman and CEO. As S&P noted in its release, “the downgrades of these four financial institutions are not the result of any company-specific event. We have not changed our view of the fundamental soundness of their depository or clearing operations. Rather, the downgrades incorporate potential incremental shifts in the macroeconomic environment and the long-term stability of the U.S. capital markets as a consequence of the decline in the creditworthiness of the federal government.”
**Full release – no link

CME Clearing is Not Planning to Adjust Haircuts Following S&P Rating Change to… 
Press release
CME Clearing President Kim Taylor made the following statement regarding the recent S&P change to the U.S.’s AAA credit rating:
“CME Clearing has evaluated the market situation surrounding the U.S. downgrade and has determined that there is no current need for changes to our collateral haircuts or policies for accepting U.S. Treasuries as margin collateral. We will continue to monitor the liquidity environment and advise market participants if the environment changes.”

Moody’s forecasts a US downgrade by 2013 
Forex NewsCredit rating agency Moody’s Corporation reiterated on Monday that it may also decide to lower the U.S. debt rating before 2013, unless the country takes significant steps to reign in it’s spending and increase it’s fiscal discipline. Now

Moody’s issues US debt warning
Alex Sawyer
Moody’s has hinted that it could downgrade US debt before 2013. Moody’s has warned the US government that it could downgrade its credit rating unless it moves swiftly to reduce its budget deficit, after Standard & Poor’s caused panic on global stock markets by lowering the country’s debt to AA+ last week.

S&P Lowers Fannie, Freddie Citing Reliance on U.S. Government
Lorraine Woellert – Bloomberg
Standard & Poor’s lowered credit ratings for Fannie Mae, Freddie Mac, and other lenders backed by the federal government. The U.S.-sponsored mortgage finance companies were lowered one step from AAA to AA+, S&P said in a statement today. The company said the downgrade reflects the companies’ “direct reliance of the U.S. government.”

S&P fallout: Fannie and Freddie downgraded 
Credit rating agency Standard and Poor’s on Monday downgraded the debt of mortgage finance giants Fannie Mae and Freddie Mac.

S&P’s Draft Downgrade Release Shows Major Revisions After Treasury Caught $2 Trillion Error
Business Insider
POLITICO’s Ben White obtained the draft copy of S&P’s downgrade press release (presumably from livid-Treasury Department officials), which shows a marked change in the section dealing with public debt — the same area Treasury accused the ratings agency of making a $2 trillion error.

The Debt Ceiling Deal: The Case for Caving
And yet for all the collective self-loathing that attended the debt ceiling talks, it’s important to remember that, like just about everything in human behavior, it was still reducible to a game. Looked at through the prism of game theory, it’s hard to see how the outcome could have turned out any other way.
**An interesting look at game theory and the debt ceiling debate

The Arithmetic of Near-term Deficits and Debt
Paul Krugman, The New York Times
Amid all the debt hysteria, it’s worth taking a look at the actual arithmetic here — because what this arithmetic says is that the size of the deficit in the next year or two hardly matters for the US fiscal position — and in fact the size over the next decade is barely significant.

G-7 Seeks to Calm Investor Fear After World Stock Selloff
By Toru Fujioka
Group of Seven nations sought to head off a collapse in investor confidence after the U.S. sovereign- rating cut and a slump in Italian and Spanish debt intensified threats to the global economy.

Origins of the debt showdown
The Washington Post/Bloomberg
In mid-January, newly installed as the GOP House majority leader, Virginia’s Eric Cantor rose to the podium inside a spacious hotel ballroom to deliver a message to his troops, including the 87 newcomers who had given the party control of the House. A vote to increase the nation’s $14.3 trillion debt limit was coming soon, he told the caucus members who had gathered at the Marriott in Baltimore’s Inner Harbor for a closed-door retreat less than 10 days after taking power. Think of it as a “hidden” opportunity, he implored them, a chance to achieve their goal of reining in the federal government and its spending habits…

Stocks extend losses on Fannie, Freddie downgrades. Dow falls more than 300 points.
CNN Money
U.S. stocks plunged Monday as Wall Street had its first opportunity to react to Standard & Poor’s downgrade of U.S. debt. The Dow Jones industrial average (INDU) was down 203 points, or 1.8%; the S&P 500 (SPX) lost 25 points, or 2%; and the Nasdaq Composite (COMP) dropped 58 points, or 2.8%.

Interest Rates

Despite pledges from world leaders, global markets continue to fall
Anthony Faiola and Zachary Goldfarb, Washington Post
Stock markets in Europe and Asia continued a bitter string of declines Monday, despite pledges of action by world leaders and a radical move by the European Central Bank to ease fears of an escalating debt crisis in the region by buying up the troubled debt of Italy and Spain. The ECB signaled after an emergency meeting Sunday that that it would invest in European bond markets in a bid to prop up hard-hit Italy and Spain, Europe’s fourth- and fifth-largest economies, which are in the midst of a worsening financial crisis.

10 Questions for Geithner
Shortly after announcing that he would remain on the job as President Obama’s Treasury secretary rather than leave the administration and return home to New York, Timothy F. Geithner sat down with John Harwood of The New York Times and CNBC on Sunday to discuss Standard & Poor’s decision to downgrade the United States government’s credit rating and America’s economic road ahead. Below is a condensed, edited view of their conversation.


Swiss left with few options to fight record franc
A shock cut in interest rates to near zero last week failed to halt gains in the Swiss franc and the Swiss National Bank now has to decide on what further steps it could take and whether to embark on costly intervention to ease the currency’s appeal.
**Volatility levels in major FX pairs trading at levels not seen since the Lehman bankruptcy. Currencies such as the Euro and Swiss Franc, which normall trade at around 9-10% annualized volatility are currently trading in the mid to upper teens.

Sterling Safe 
Here’s a safe haven idea you have not have thought of: The Great British Krona. Standard Bank’s Steven Barrow points out that sterling has fallen, on a trade-weighted basis, much more than the other major currencies:


Gold Tops $1,700 for First Time on U.S. Rating 
Gold climbed to more than $1,700 an ounce for the first time after Standard & Poor’s cut the top U.S. credit rating, fueling a slump in equities and the dollar amid concern that the global economy is slowing.

Gold Breaks $1,700
The spot price of gold surged above $1,700 a troy ounce, setting new records, as continuing concerns over European debt and an historic U.S. credit-rating downgrade sent investors flocking to the perceived safety of the yellow metal.

Precious Metals – Resource Investor
Monday morning was shaping up to become a heck of a hectic day in US markets following overnight routs in European and Asian equity markets.


In Crisis Mode, Hedge Fund Managers Turn To The VIX
Kenneth Rapoza – Forbes
Looks like the biggest derivatives trade of the week is buying VIX options. That’s the way most hedge fund managers are going to protect themselves from wild swings in the market, expected all week long thanks in part to the US credit downgrade to AA+ from AAA by Standard & Poor’s on Friday, and the ongoing sovereign debt drama in the eurozone.
“My option strategy is the VIX and only the VIX,” says Joel Smolen at Axion Capital, a San Rafael, Calif hedge fund.
**On Friday, CBOE reported that the VIX options hit a record 1.19 million contracts and VIX futures hit a record 152,067 contracts.

A Flash ‘Surge’ In the VIX? Not so Fast 
ETF Trends – Paul Weisbruch, Street One Financial
The equity markets suffered further losses Monday after feeling under enormous selling pressure late last week, capitulating at one point during Friday’s session when the S&P 500 Index traded as low as 1168.09.
For most of the trading session on Friday, equities traded in the red (with the Dow closing higher after eking out a gain) and at one point, with equities trading at their lowest levels since late November of last year, we actually saw the VIX (CBOE S&P 500 Volatility Index) leap fiercely and suddenly, trading as high as $39.25. This was the highest intraday price point touched in VIX since May of 2010 (during the week of the Flash Crash).

NYSE Invokes ‘Rule 48′ To Smooth U.S. Stock Market Open 
By Jacob Bunge
The Wall Street Journal Online
The New York Stock Exchange early Monday put into effect its so-called “Rule 48,” aiming to smooth the opening of U.S. stock trading in what is expected to be a rocky session. Rule 48 allows designated market makers on the NYSE to refrain from disseminating price indications ahead of the opening bell. The idea is to make it easier and faster to open stocks on days when trading is poised to become especially volatile.

Environmental Markets

EU carbon price plunges to record low as focus returns to Greece
Business Green
Carbon prices on the European Emissions Trading Scheme (ETS) fell to a fresh low yesterday as the market continued to be weighed down by the Greek debt crisis. Benchmark EU Allowances (EUAs) hit a 29-month low of 11.05 euro, before rebounding slightly to close at 11.43 euro, 2.64 per cent lower than the close on Tuesday.

Carbon Mostly Ignoring Any Bullish Indicators, New Energy Says
European Union carbon permits are less correlated with increases in energy prices, equities and the euro than they were with declines, according to Bloomberg New Energy Finance. Analysts at New Energy Finance including Clemens Tummeltshammer in London averaged the daily price movement of a basket of benchmarks containing energy prices, equity indexes and the euro for the past eight weeks. The correlation was 10 percent on days when prices rose and 48 percent on down days, they said in an e-mailed research note dated today.


Europe’s Crisis May Stuff U.S. Banks With Undeployable ‘Hot Potato’ Cash 
The European debt crisis is poised to flood U.S. banks with something they don’t want and can’t use: more money.
Cash held by U.S. banks surged 8.4 percent to a record $981 billion during the week ending July 27, the Federal Reserve said in an Aug. 5 report. That’s more than triple the amount firms had in July 2008, before the collapse of Lehman Brothers Holdings Inc. almost froze bank-to-bank lending.
** An unintended consequence of Dodd-Frank – Change in FDIC premium methodology as of April 1 leads to negative real interest rates.

Downgrade of U.S. debt rating heralds a new era
Mohamed El-Erian – PIMCO – Financial Times
There will be endless debate on whether S&P, the rating agency, was justified in stripping America of its AAA rating and — adding insult to injury — even attaching a negative outlook to the new AA+ rating. But this historic action has now taken place, and the global system must adjust. There are consequences, uncertainties, and a silver lining.
**Regulatory conundrum: Who rates the raters?

Regulatory debate continues on merits of short selling in turbulent markets
Hedge Funds Review
Regulators continue to disagree on rules to curtail short selling. Empirical evidence suggests constraining short sales significantly reduces market quality and can have unintended consequences.

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