Banks' credit downgrades doesn't mean the sky is falling — but it can still fall

Bloomberg News

If you write for a living — or even if you just majored in English — you will likely accumulate over a lifetime a list of cliches, hotel-room proverbs or misremembered turns of phrase that drive you crazy. My personal least favorite is the phrase "vise-a versa" instead of "vice versa," or any earnest reference to Washington, D.C. as "this town."

But another one that I try to avoid is the expression "the fish rots from the head," which is meant to say that when things go bad it's the fault of whomever is in charge. As someone who has seen a lifetime's worth of dead fish, I can tell you that all parts of a fish that is no longer living will decay at an equal rate — the expression perhaps comes from the observation that seagulls and other wildlife will often eat the head of a fish first. 

With that being said, just because an expression is not literally true does not mean that the metaphor doesn't hold true, as it does when applied to today's news that Moody's downgraded a number of regional banks and are poised to downgrade several large banks in the coming weeks. That news comes a week after fellow bond rating agency Fitch downgraded U.S. sovereign debt — and more than a decade after S&P did the same — and those downgrades were both attributed to greater uncertainty around the U.S. government's ability to perform its minimum fiduciary duty to honor its debts. 

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These are two separate things, but they are related. Moody's downgrades are largely reflective of the overarching interest rate risks that banks face right now — costs of funds are going up, values of long-dated treasury bonds are going down, and margins are getting tighter. So over time, as those long-dated bonds mature and the zero-interest-rate episode between 2008 and 2021 works its way through the financial system, there is reason to think banks will navigate these straits and end up being fine. 

But at the risk of repeating myself, there is also reason to be concerned about whether the United States will continue to functionally govern itself as a single unit or will devolve into an Andy Capp cartoon. The debt ceiling is something we're not talking about as much anymore, but we all know it's going to be back. And I sincerely worry about what is going to happen after the 2024 election, regardless of which candidate wins.

That's the bad news. The good news is that, at least for now, there isn't another sovereign debt game in town that comes anywhere close to rivaling the United States. If you look at a list of credit ratings for sovereign debt, you will find several that are more highly rated than the U.S. — Denmark, Australia, Switzerland, etc. But the closest rival that reflects the economic scale of the U.S. is the EU, whose credit rating is about the same but whose governance is far more confederated than ours. That makes it hard to compare apples-to-apples. By contrast, non-democracies — China, Saudi Arabia, Russia — are far, far riskier and thereby far, far less attractive as a store of value. 

That should be instructive for those individuals of all political stripes who are in positions of power. It is they who occupy the head of this collective fish we call the United States, and as such have the power to keep us healthy, alive and swimming in the water. If our governance risk continues to deteriorate, we all could be left to rot.