Q&A: U.S. Treasuries are global benchmark

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Why is the Triple A rating important?

It's the highest possible credit rating and U.S. Treasuries have always had it, making them the global benchmark for a safe investment. Interest rates on many other securities are based on Treasury rates. A downgrade of America's credit worthiness could make borrowing more expensive for everyone from businesses to individuals to state and local governments.

"All bonds are marked off of treasuries," said Mark Luschini, chief investment strategist for Janney Montgomery Scott. If the market reacted to a downgrade by demanding higher yields, "that would filter right through the credit markets because all other bonds would be treated as having additional credit risk in light of the fact that what had been deemed to be the safest credit issuer in the world, no longer holds that status."

What would be the impact if the rating is downgraded to AA?

It's never happened before, so a lot remains unknown. There could be a sell-off by investors fleeing Treasuries.

"Legally many retirement funds, many companies can only hold Triple A securities, so we don't know how much forced selling there would be in the market," said Joseph Foudy, an economics professor at New York University's Stern business school.

On the other hand, there could be a rally if investors instead looked to Treasuries as still being the safest, most liquid investment in an uncertain world.

"The market's already thinking there's a high probability of a downgrade yet if you look at where Treasury securities are, long-term interest rates are still extremely low," said Nigel Gault, chief U.S. economist at IHS Global Insight, a financial research firm.

Still, because Treasuries are tied to so many parts of the economy, many fear serious ramifications.

Areas of concern include:Consumer interest rates:If investors demand higher interest rates on Treasuries because they are seen as riskier, then fixed interest rates on new home and car loans would also go up. People who already have fixed rate loans wouldn't be affected. Variable rate loans and lines of credit on the other hand, would go up. Customers with home equity lines would see their interest rates go up in that case, said Michael Vittorio, chief executive of First National Bank of Long Island.

Housing market:Higher interest rates on homes could drive housing prices down further.

 

Taxes and municipal financing: States that are more reliant on federal spending could see rating pressure and face a downgrade that would increase the cost of borrowing. And if Treasury rates go up, rates would probably go up for state and local government bond issues.

 

Economic activity:If interest rates go up, then businesses will pay more to borrow money at a time when the economy is fragile.

Who buys and owns Treasury bonds?

The largest investors of U.S. Treasuries are foreign countries like China and Japan. Treasuries have unparalleled liquidity, which means sellers can easily find buyers in a market where $580 billion of Treasuries trade daily. This means that central banks, commercial banks, investors, insurance companies or other buyers know that they can easily convert the bonds to cash or use them as collateral in financial transactions. There are no comparable alternatives to Treasuries. The United States has issued $9.3 trillion in marketable U.S. Treasuries compared with $1.9 trillion of French government bonds and $1.8 trillion of United Kingdom government bonds, according to a report by Fitch Ratings.

"There's really no viable alternative at the moment," said Fitch analyst Robert Grossman.These credit agencies have been wrong in the past. Why does it matter now?

The major credit rating agencies, Moody's Investors Service, Standard & Poor's and Fitch Ratings, took a beating after the financial collapse of 2008. But they're still the main game in town. If U.S. bonds are downgraded, how would they earn back the AAA rating?Rating agencies say that depends on how long it takes for the U.S. government to raise the debt ceiling and address its long-term revenue and spending imbalance.

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