US Credit Downgrade

Gary Gibbons, Ph.D., visiting professor of entrepreneurship at Thunderbird School of Global Management, talks about the U.S. credit downgrade and how it impacts Arizona.

Transcript:

Ted Simons: Good evening and welcome to "Horizon," I'm Ted Simons. The ramifications of the U.S. credit rating downgrade are still being felt in a variety of ways, most notably on Wall Street. But what does the downgrade mean to Arizona? And where does the state and country go from here? Joining us with some perspective on the downgrade is Gary Gibbons, an expert in investing and corporate finance, and a visiting professor of entrepreneurship at the Thunderbird School of Global Management. Thank you for joining us.
Gary Gibbons: Thanks for having me.
Ted Simons: Were you surprised by the S&P downgrade?
Gary Gibbons: No. The S&P were telling us a long time they were intending to downgrade. They laid out their reasons, and what the government had to do in response to the negative watch they put the government on. In fact, they followed through with what they said.

Ted Simons: Yeah. And I know that their press release was relatively succinct. I think we have it here in a second. It says it's basically the debt and the government that is lowering of the rating was prompted by a perception of grating policy-making uncertainty consistent with our criteria. Again, not surprised?
Gary Gibbons: No, not at all. They did exactly what they said they were going to do. In their view, the deal that was struck last week in Congress was not sufficient. And they also doubt the ability of the different parties, the presidential branch, and the Senate and the house to get together and resolve the issue.
Ted Simons: Why trust S&P? I mean, these folks didn't have a very good track record with those mortgage backed derivatives. Why do we put so much trust in them?

Gary Gibbons: That's a good question, they have had some notable failures. Enron was one of them, the mortgage-backed securities was another one. However, for the times they have gotten it wrong, they have gotten it right a lot of other times. The reason we trust S&P or Moody's or Fitch or anyone like that is because they represent an independent view. When they do ratings, they do publish reports that explain exactly what their view is. Now, if they miss something, that's a problem. But in general they typically do get it right.

Ted Simons: I know some critics are concerned because they are paid by some of the companies they rate. Talk about that concern and talk about that situation.

Gary Gibbons: Well, they do get paid by companies that they rate. When they rate sovereign debt, they get paid by funds that subscribe to their sovereign debt reports. They get paid both by the people they are rating and the people that consume their advice. But I can't think of any other way to do it unless you had a government agency doing the rating and that wouldn't resolve the problem.

Ted Simons: So with that in mind, for those who say there's too much dependence on credit ratings, when an S&P can do this and Wall Street blows up. You would say that's the nature of the beast?

Gary Gibbons: Well, S&P did it, it didn't have much effect on the U.S. Treasury markets. It did have a lot of effect on Wall Street, I agree, but there were other issues in the economy Wall Street was also worried about at the same time. The crisis in Europe is very substantial. What the French bank and the German banks are going to do with Italy and Greece, these countries, that's a big unknown, as well. It's as dangerous if not more dangerous right now than the downgrade of the U.S. debt.

Ted Simons: Back to the downgrade and back home here: How does that downgrade impact everyday life and business here in Arizona?

Gary Gibbons: Well, I would say the first place that it affects all of us here in the state is that our debt, the debt that's issued by our revenue districts, like the airport authority or the board of regents at the universities, that debt is in danger of getting downgraded, as well. Because when you have sovereign debt downgraded, then you have S&P looking at all other debt that follows along the line behind the sovereign debt, and giving more scrutiny to that debt. S&P in fact downgraded 5,000 issues nationwide of municipal debt. I expect that's going to be an issue.
Ted Simons: It's interesting you being up on municipal debt. I would think if you're a city or a town, if you've got a Triple-A rating, which might be a relatively attractive place for some folks to park their money.
Gary Gibbons: Well, I think that would be a Triple-A municipal debt that's fully guaranteed by general obligation of a state or a municipality would be good solid dote have right now. We don't have any general obligation debt like that in Arizona. The Arizona constitution forbids the state from issuing general obligation debt, for all practical purposes. So for us, we are looking at debt that is not rated as general obligation debt, obligation of the state. But debt that's an obligation of, oh, the universities and it's funded or paid only from the revenues that are -- that the universities receive from tuition or from a sewage district or a water district or something like that. That makes that debt more suspects, especially in a time of economic slowdown.

Ted Simons: So impact on cities and towns, yes?

Gary Gibbons: I think they will see their debt given more scrutiny. We'll have some downgrades. I think Dysart School District was downgraded already and a few others.

Ted Simons: There are a few issues regarding the debt deal, as well, including a trigger if something doesn't get figured out here. Talk to us about how that might affect Arizona.

Gary Gibbons: Well, that's a good point. The congressional select committee has to provide a report to Congress about what they are going to suggest, about a trillion and a half in cuts that they are going to try to generate by Thanksgiving. If they don't manage to do that, then there's going to be a debt trigger that kicks in. It simply says, arbitrarily, that we're going to take a trillion and a half out of entitlements, 50%, and the defense budget 50%. Arizona has a lot of dependence on the defense budget. We have three major bases; we have Luke, Davis-Monson and Fort Huachuca. We have to work hard to save those bases and keep them from being cut. Plus, we have a defense industry that has a pretty substantial presence in our state. If we get to that trigger and $750 billion is taken out of the defense budget, Arizona is going to suffer.

Ted Simons: All right, great information. Thank you so much for joining us, we appreciate it.

Gary Gibbons: Thanks for having me.