Federal Reserve officials publicly declared it was business as usual in the face of Standard and Poor’s downgrade of US government debt, but privately they acknowledged these were unchartered waters.
Within 90 minutes of S&P’s decision, a joint release from US banking regulators declared that, despite the downgrade of US paper, there would be no change in the risk-weighting of treasury bills, bonds and notes or any paper guaranteed by the US government. In other words, banks do not have to post any additional capital against their Treasury positions.
Regulators also announced that the treatment of US treasuries at the Fed’s discount window would be unchanged. Typically, the riskier an asset, the more collateral banks have to post to borrow from the Fed’s emergency lending facility.
Fed officials met in the past two days to consider the impact of a downgrade on markets. They concluded that, other than the unknowable impact on sentiment, there would be little impact.
They suggested that there was not much money that would have to "mechanically" sell treasuries because of investment restrictions. So they didn’t expect much, if any, forced selling.
Even if there were, they concluded that interest rates were so low that any potential rise in rates would cause little economic damage. They noted that treasury yields actually fell during the debt ceiling debate with its threat of default and downgrade because the US is still considered a safe haven.
In addition, they say that the S&P downgrade provides little new information about the US debt situation that the markets didn’t have already. And markets have been on notice from S&P for several weeks of a possible change.
But Fed officials acknowledge they cannot quantify the potential psychological impact on markets of the downgrade.