What S&P Debt Ratings Mean for the U.S. (and Its Citizen Shareholders)
Published on - August 10th, 2011 (by Sarah Gilbert) This post is from new staff writer Sarah Gilbert. We’d planned for her to make her debut later, but Gilbert offered to write about the current economic situation, so she’s stepping up the plate a little early. This is a rare GRS foray into current events. Do you like it? Hate it? Not care either way? Let us know. (I’ll do a formal introduction for Gilbert later; for now, a mini-bio is at the end of this post.)
It’s tough for a girl who’s worked in junk bonds to get too excited about the downgrade of U.S. Government debt from AAA to AA+. When I was an investment banker at First Union (now Wachovia) in the 1990s, in fact, I would routinely shake my head at people who called it "junk." We called such debt — BB+ and below — "high yield." The yield, or interest rate, could be higher on companies that were deemed riskier investments; so the mostly institutional investors who bought the bonds could count on making a lot more money.
In the time-honored risk/reward ratio, the more the risk, the better the reward; we young investment bankers almost felt we were cheating sometimes, charging LIBOR — the base rate banks use to reflect market rates — plus two or three basis points for debt we privately felt was far safer than any equity.
Cause and effect?
As much as I may shake my head, the markets have had a big reaction. The Dow Jones Industrial Average was off over 630 points, or 5.55%, on Monday in response to the news. Even though the market had a recovery Tuesday, the average of top stocks is still down 1,000 points (about 10%) what it was just 10 days ago. The debt ratings don’t have an immediate effect on any one company’s prospects, of course; it would make far more sense to see such a reaction to the credit ratings of the companies which make up the Dow; but the DJIA is seen as a barometer of investor sentiment. The people are very worried.
I was staying in a hostel in San Diego when the downgrade occurred, and on Sunday I overheard two men huddling in the common eating area and predicting dire things for us all. They were worried: another example of that poor investor sentiment, perhaps, or just generally bad mood all around. “Why can’t our government get its act together?” everyone seems to be asking.
It’s instructive to think about how, exactly, debt ratings work, and what they should mean to you. If, as many pundits are saying, a downgrade from AAA to AA+ doesn’t really mean anything, why is everyone so upset? Why the damage control from Washington?
How debt ratings work
At their most basic, debt ratings are an estimate of how likely the indebted will pay back what is owed according to the terms of the initial lending agreement.
For government bonds, that lending agreement is described in the treasury auction, or the launch of the T-bills in question. Take a standard measure of global lending sentiment, the 10-year treasury note. It pays interest twice a year, and then the principal is paid back at the end of the 10-year period.
If ratings agencies (which are, as most of us remember from the banking crisis, private companies operating independently and, largely, secretly) believe that a government has a 100% chance of paying both the interest and principal on time, the rating would be AAA or its equivalent. For such a "risk-free" investment, the yield, or interest rate, is comparatively low. The most recent such rate was 2.306%. Greece’s debt, as a comparison, pays out over 15% for a ten-year bond.
Many experts believe that government debt ratings issued by S&P are almost meaningless for a number of reasons; chiefly because the bonds are purchased by large "institutional investors"; in other words, banks and insurance companies whose business it is to figure out how likely a corporation or government is to pay back debt. They’ve already done the math; for U.S. treasuries, the math is probably done once a week or so.
What’s at stake?
In finance (as in fiction), the biggest question to ask is always this: "What’s at stake?" Debt ratings are the best guess at answering that question. (There’s nothing so quantitative for novels, sadly.) The worst-case scenario is always that a debtor won’t be able to pay interest, and in the end, won’t be able to pay principal either.
Take your average "junk" status company, with a BB+ rating or below. (Those were the majority of my clients when I was an investment banker.) The probability of default is somewhere between 5% and 8% of all borrowers. But even in the worst-case scenario (think Greece or the average underwater American homeowner), instead of going belly-up and declaring bankruptcy, borrowers typically restructure their debts — asking lenders to agree to more relaxed repayment schedules or lower interest rates in return for not losing everything.
It’s instructive to note that, in the case of a liquidation, debt holders get paid before equity holders. Take a company like Ford, which is rated BB-. If Ford were to declare bankruptcy and sell everything, after salaries and taxes were paid, the debt holders would be paid the principal they were owed, and then, last, the stockholders, who would probably get nothing.
Countries really don’t have the option of shutting down and selling all they own — especially not the U.S. And everyone seems to agree "the U.S. will not default on its debt!" — so the debt rating issued by S&P is more of a scolding than anything. And, just as in corporate stock, what’s good for the debt holders may not be good for the equity holders (who are, as I see it, the American public in this case); the austerity measures being taken by Congress will not help the American people or expand the economy. But it will make it easier to repay the debt.
You know what Shakespeare wrote: "neither a borrower nor a lender be"? It’s hard to see, in the modern economy, how this can be true; it’s the owners who end up losing every time.
Sarah Gilbert was once an investment banker. After graduating from Wharton with an MBA in 2000, she bit on the dot-com hook and flopped around for years in management at various startups. She began blogging professionally in 2004, and worked for AOL for several years, launching and managing BloggingStocks and WalletPop. Now she’s an award-winning writer, about everything from food to finance to life as a military wife.
We’re excited to have her join the staff at Get Rich Slowly.
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Unlike most, I don’t think our world is coming to an end.
The stock market has been hovering for a few months now, and I knew that it was ready to crumble downwards; all it needed was some negative news. Well, that news came just a few days ago and boy did the stock market dive!
When the market is driven by fear, it’s obviously not going to be a money-maker. At this point, it will hold steady for a while and begin it’s rise (though I think today, it will fall slightly again… -200 points or so on the DOW).
If the unemployment numbers get below 9%, then I think the American mindset will change. They’ll lose their fear and our market will take off once again. I’m going to be ready to ride that train!
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Even if the economy doesn’t improve (or get worse) won’t we reach lower than 9% unemployment as the long term unemployed run out of benefits and are no longer counted in the unemployment number?
Sounds like the market is a fickle, fickle place.
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Actually jobless claims won’t affect the Current Employment Situation. The current employment situation is a survey of jobless claims and worksites. http://www.bls.gov/ces/
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I guess your guess was wrong—down 519 today!
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Nice to see a market post in here again.
Single line that made me smile?
“I was staying in a hostel in San Diego when the downgrade occurred”
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I’m planning a future post on using hostels; so I’m glad you enjoyed that reference!
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Great article.
I’d love to see a follow-up on the potential global impact of this whole situation. The political circus going into the august 2nd deadline focused almost exclusively on the consequences for the US economy and US investors – not surprisingly, given the audience they were playing to – but I’d love to see an article addressing the global side.
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thanks, Kate. The only place I’ve seen much discussion of this is at NPR’s Planet Money and the BBC; to date, no one has really posited that it WILL have any effect globally. Of course, the more macro issues will have an effect; if, indeed, the U.S.’s austerity measures create an environment in which the economy can’t grow, it will have a far-reaching impact on global demand. In my opinion this could cause a vicious circle, given that so much American consumer spending comes from China; and China is the biggest purchaser of U.S. treasuries. If China is selling less to us, they’ll be less able to be our lender. (hmmm. this would be really interesting to explore!)
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The down swing of the stock market two days ago and then the upswing yesterday taught me one thing: patience is a virtue. As an amateur investor, if I decided my investing strategy based on the upticks and downticks of the DJIA I would have a stroke.
Dollar cost averaging is your friend, and Index funds are your best friend. Steady investments and a long time horizon are the easiest and most consistent way to invest.
I don’t worry about the debt downgrade. In fact, I think it might be a good wake up call for so many people who think the US is impervious to error, and that we really don’t need MAJOR changes in this country.
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I wrote an article about this today as well. There is absolutely no evidence for a USA downgrade. This is a purely political play from Standard and Poor’s (or a gambit to gain more publicity, which it obviously did).
I like the market articles and cheers for the new author!
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“the austerity measures being taken by Congress will not help the American people or expand the economy. But it will make it easier to repay the debt.”
These two sentences don’t agree. If the economy contracts it will be harder to repay the debt. Tax revenues will be smaller. Long-term growth will shut down.
http://nicoleandmaggie.wordpress.com/2010/08/27/keynesianism-101/
On Friday grumpyrumblings will have a chart showing the country’s long-term problems graphed against its revenue.
Yes, we need to cut future spending and raise revenues in such a way that short term growth is not stunted. Let’s not have a second great depression. Let’s not even have a double dip recession. We need to solve long-term problems sooner rather than later so the cost is spread out among more people and is easier to bear.
And if you haven’t done it yet, write your congressperson and ask them to be willing to negotiate a long-term solution, or we really will have long-term problems.
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“We need to solve long-term problems sooner rather than later so the cost is spread out among more people and is easier to bear.”
I wish people would stop trying to “spread the sacrifice”. The real truth is if we could just lower the taxes, the tax revenue would INCREASE, yes, INCREASE, and we’d be closer to an economic recovery. Tax decreases also free up companies to hire more workers, thereby adding even more tax REVENUE by having MORE TAXPAYERS.
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So wrong on so many levels. Reagan tried it, Bush Two tried it and both times it didn’t work. Based on my study of business and economics I sadly conclude that the best thing would be for my taxes to increase with the revenue going to government sponsored job creation. A lot of non Tea Party Republican politicians agree although you will never hear them say so until they retire from office.
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“So wrong on so many levels. Reagan tried it, Bush Two tried it and both times it didn’t work.”
Really? Is that why the unemployment rate dropped dramatically both times after those tax cuts? Bush 2′s tax cuts had our unemployment rate at 4.9 percent, DESPITE 9/11, a direct result of lowering the taxes on “the wealthy”. Why do people have such a selective memory when it comes to tax cuts? When Kennedy made huge tax cuts in the 60′s, it also created a more vibrant economy. It happened again under Reagan, and it happened again under Bush. It is a HISTORICAL FACT that tax cuts CREATE MORE TAX REVENUE. It may not make sense, but it is a fact.
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Barbara is right and wrong.
Catherine, you are just wrong.
The economy’s jobless rate lowered when marginal tax rates were reduced. However, this time just lowering the marginal tax rates won’t work. We have to get people at the bottom end of the tax spectrum to start playing taxes again. The federal government has to get out of the business of giving away “free” money. Broadening the tax base will help to bring in new revenue, demonstrate the TRUE cost of government, and provide understanding why low taxes for all is beneficial.
If you do not pay taxes then you will find little reason why you should LOWER other people’s taxes. If you are the recipient of a government program then you are not paying for then you will always want more. The end result is bankruptcy. This sentiment is far worse and damaging to a nation than a credit downgrade.
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@Barbara you’re mixing things together, talking about unemployment and tax revenue as if they mean the same thing. Whatever employment did after the Bush tax cuts, revenue (measured as a % of GDP) did not increase. The economy may have been growing, but tax revenue was not growing as fast.
If you don’t believe me, check this link:
http://www.usgovernmentrevenue.com/downchart_gr.php?year=2000_2010&view=1&expand=&units=p&log=linear&fy=fy12&chart=F0-total_F0-fed&bar=0&stack=0&size=l&title=&state=US&color=c&local=s
As to your greater point, I think you might be missing a subtle point. All the studies I’ve seen on the matter show that tax cuts do have a stimulative effect that helps make up for *some* of the tax cut, but not *all* of it. In other words, the net result is lower tax revenue, but not quite as much lower as the cut itself.
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Lowering taxes for the wealthy creates jobs…
…in China!
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Catherine is right.
There must be an equilibrium at which taxes are “just right.” You cannot simply state that lowering taxes is always the answer to greater government revenue – that cannot be the case. You can, however, argue that bringing the marginal tax rate down from 90% to 40% will bring in more revenue for all sorts of reasons (incentives being a large one), but benefits of that cut do not necessarily apply when the rate is cut from 40% to 20%.
The answer cannot be that taxes should always be cut to stimulate growth and government revenue. If you don’t understand this, you don’t understand economics.
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Thank you, Adam, for explaining this so eloquently. On a less economically based, more personal level, I would be pleased to pay more taxes for jobs creation programs to rebuild the nation’s infrastructure. So many of my friends have been out of work for months and even years and would love to work and pay taxes if only they could.
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@Adam Indeed, and a nice way to frame the issue. Taken to either extreme, 0% taxes would certainly not raise revenue and 100% taxes would not be productive either. So the best choice must be somewhere in the middle.
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Companies are sitting on $2 TRILLION dollars of cash instead of hiring. Lowering taxes does not create jobs. Getting of regulations does not create jobs. DEMAND for goods and services creates jobs – and when your average Joe has decreased spending (due to unemployment or the threat of unemployment, a need to increase personal savings or decrease debt due to the threat of unemployment, effectively flat wages, or just a general lack of financial confidence due to losing wealth in the housing or stock markets) then demand for goods and services goes down.
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The question is:
Who creates the job for Joe?
and
Why are they sitting on the money?
They don’t sit on the money just to be mean. They sit on the money for rational reasons.
All of this discussion is simplistic, but I think a bottom line is taxes are dynamic. Simply raising taxes won’t necessarily raise revinue and lowering taxes won’t necessarily lower revinue.
The arguements are: 1) Lowering taxes at this point may raise revinue by increasing the number of people paying taxes. 2) Lowering corporate taxes may raise revinue by bringing business back to the US. and 3) Lowering taxes generally (capital gains and other taxes on money movement) by repatriation of money and bringing the capital back from overseas to invest in jobs here.
Really it comes back to the idea of taxing desirable behavior less and undesirable behavior more.
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@Shara “Lowering taxes at this point may raise revinue by increasing the number of people paying taxes” is indeed the argument. Is there any evidence supporting that argument? All the evidence I’ve seen is that cutting taxes reduces revenue as a % of GDP. Seems pretty straightforward.
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Shara:
“Who creates the job for Joe?” The business, in response to demand for their product or service.
“Why are they sitting on the money?” Because there is not additional demand for their product or service.
“They don’t sit on the money just to be mean. They sit on the money for rational reasons.”
I never said they were mean. Supply and demand are perfectly rational reasons upon which to base hiring decisions.
I would argue that the lowered unemployment rate Barbara mentioned during Bush II was not due to the Bush tax cuts, but rather a) an exhortation from our president to spend spend spend in the aftermath of 9/11, and b) an overall increase in consumer confidence due to gains in the stock and housing markets; indeed, many people took home equity loans during the middle part of the decade to spend housing gains on vacations, electronics, cars, etc. DEMAND was up and businesses responded accordingly by hiring to meet that demand. That level of demand is no longer there, and businesses have also responded accordingly.
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Point 1)
Here’s a chart of job loss/creation since 1/2001 from the bureau of labor stats:
http://data.bls.gov/timeseries/CES0000000001?output_view=net_1mth
It shows the dip in employment after 9/11, its return to previous levels and then the HUGE drop off that didn’t turn around until 2009 (and continued up right through all that stimulus spending, just as predicted).
Is it good enough? Nope, but clearly in the right direction.
Point 2)
Companies right now are sitting on huge cash reserves. Biggest in history. What exactly will tax cuts (especially since most large corporations are paying very little in taxes, if any) do to get this money out there?
http://www.guardian.co.uk/money/blog/2011/aug/05/tackle-corporate-tax-avoidance
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Nicole – I was thinking the same thing. If we really want to get the debt under control, getting people employed again in good paying jobs so they can pay taxes (and incidently use less govt services) is an essential factor.
Great article Sarah.
I would like to see a little more “current event” stuff like this. Although I have to say I’d prefer it not get too political, I think these days that’s gotten way too polarizing. I can get that elsewhere.
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I really enjoyed this post and look forward to more from this writer.
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Great post… thanks for explaining the situation in common, everyday language.
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Are all bankruptcies handled as described in the article?
I seem to remember the bond holders of GM being forced to accept equity in the new GM so that the UAW would receive their “fair share” of the value of bankrupt GM.
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Liquidations essentially are. In a restructuring, then it is fairly common for debtholders to be given equity in exchange for their debt claim. What constant is that equity-holders come last.
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thanks Panda. There are two types of corporate bankruptcies; one is a restructuring (which could be compared to the situation in Greece), where the debtholders agree to take less principal or to receive part of their debt in equity (as in the GM example), or some other change in terms; the other is a liquidation, where everything of value is sold and the proceeds are divvied among those who are owed money. As I mentioned, in liquidations the salaries and taxes owed are paid first; secured debtors second; unsecured debtors third; and finally, equity holders. In the dotcom boom-and-bust years, I worked with a banker who was responsible for selling the equipment of failed companies; most of them only get about 10% of the original value in such sales, he said. of course, this is a situation that can’t possibly be applied to a country.
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When stocks plummet, everyone turns to bonds. So when bonds look bad, people should be turning to stocks, which should increase the price. And they should become more afraid of bonds which should increase their interest rate. Yet somehow stocks are dropping, and interest rates keep sucking. I really don’t get it.
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I think that most people took the downgrade of USbonds to be more of an indictment of the economy and the inability/unwillingness of the govt to do anything about it, raher than anything to do with the actual ability to repay the bonds. Everyone flocked to bonds because that’s still safer than stocks as we dip back into recession part 2.
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You’re right, it doesn’t make sense. However, just this morning as a friend was dropping off his kid to play with mine, he commented that his broker had called *him* yesterday and said to take all his money out of equities and put it into bonds.
This is advice not given to someone who is near retirement age…in fact, I think he just turned 40. So, he’s selling on the way down…and will have to rebuy…when it’s higher? It truly makes little sense to me, especially when you look at corporate cash holdings and profits right now.
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Time to dump that broker… if the guy is 40, he should just hang on and ride it out. Selling into the dip is a bad idea, locking in your losses.
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Ah a little fear in the country/Market means a bigger paycheck for the Broker. Drop the bum. Only give your money to someone after you have seen their income tax return, FICO score and their brokerage account.
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I really enjoyed this article and look forward to more from this author.
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I think Sarah did a great job in her article of being clear and casting a critical eye at the downgrade which is being reported like a falling sky by Chicken Little.
J.D. I’d be very curious to see what kind of stats you get for hits/time spent on this article.
I’ve found little interest in current events topics in my home buying classes. No one is interested in changes in how appraisals are done–until they buy a house that doesn’t appraise for what they’re paying for it. Then, suddenly, it’s the most fascinating topic in the world.
Linking this explanatory article with one that highlights potential effects on individuals could be very helpful.
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I too am interested in articles that show how events in both the U.S. and world economies affect everyday people. IMHO we are sliding into a 2nd recession (actually I think we are in the middle of another Depression – there appear to be parallels between what’s happening now and events of the 1930′s) and I would like to see articles on how that will affect us and what to do about it.
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thanks, you two. I will try to write more posts taking an economist’s view of how our fiscal policy choices may end up affecting you and I — and what, if anything, we should do about it!
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Remember it was rating agencies like Moodies that gave compinies like Enron high ratings and helped Bear-Sterns and Goldman-Sacks sell toxic crap CDO’s to the world. This may be my little screed but I dont trust anyone in the financal industry, people like Sarah should all be ashamed and have to serve public service time for helping to put the Western World on the brink of economic depression. GREED…GREED. There is a reason it is one of the 7 deadly sins.
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And it’s not going away, so let’s try practical solutions that acknowledge it rather than pontificate about tossing them in jail. Nothing drives me crazier than a solution that essentially starts with getting rid of greed.
It reminds me of math jokes that prove 1=2, all predicated on allowing you to divide by zero. The problem is that you CAN’T divide by zero.
Let’s not outlaw greed. I admit greed is a motivator for me and I don’t want to go to prison. In fact most people here would probably be locked up with me, otherwise why are you trying to get RICH slowly? Let’s instead agree on unfair and unethical behavior. After all if someone cheats the system I don’t really care if their motivations were altruistic.
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Agreed. Greed is to be expected and we need to just be smart about regulating and enforcing. And that includes changing outdated or outmoded regulations as institutions find “work-arounds.”
It’s not a problem that is solved once and done, but one that requires constant watching and some tinkering. (Sort of like all the long-term important tasks.)
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Whether “people like me” should serve jail time is certainly a matter of opinion. I worked in loan syndications and mergers and acquisitions; while you could find fault with such divisions, they’re simply making sure corporations have money to grow, create jobs or do deals (some of which, admittedly, have terrible consequences — the bankers don’t make those decisions, though). Your anger is perhaps better placed with those who work in hedge funds and creating the sort of mortgage securitization products that sent our real estate market into crisis. This speculative stuff was not what I ever worked on — and I was out of investment banking and sunk deep in the dotcom world far before the current crisis was even conceived. The closest I ever came to it was going on three coffee dates with a mortgage securitization associate. He was a boring one, though, no chance of devising such schemes to bring markets to their knees.
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I’m very interested in current events. I’m having a hard time seeing how all of this economic mess will affect my day to day living beyond the basics of a crap job market and loooooow interest rates. In the news, you are lead to believe that the debt ceiling is a HUGE deal and everyday people are in an absolute panic about it, but I just don’t understand. Thanks for starting to explain it to me in a way that I can understand and in a way that seems, to me, that there is no ulterior motive for panic induced ratings.
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There’s no quantitative measure for fiction because fiction is a tool for exploring the human experience — for holding up a mirror to society and saying what’s wrong with it, or for getting us to ponder those probing, crucial questions about life, human nature, the universe, and everything. “Why are we here? What is the best way to live my life? What is love? What is honor? What is justice?”
Those life questions include questions about the importance of money and the effects of debt. Just think about Dickens’ Ebenezer Scrooge, who was so narrowly obsessed with amassing quantities of money that he had to be taught by the ghosts of Christmas past, present, and future that human relationships are more important than anything else. Or Flaubert’s Madame Bovary, who overborrowed, in an attempt to escape the boredom of her quiet country life by emulating the lives of the wealthy, and wound up committing suicide by eating arsenic because she couldn’t repay her debts. And look at The Merchant of Venice. It begins with the character of young Bassanio confessing to his older friend Antonio that he has lived WAY beyond his means, that he intends to fix his financial situation by marrying a rich girl who seems to find him attractive, and that he needs to borrow yet more money from Antonio in order to look like he can compete with all her other wealthy suitors. (Potential nightmare of a husband. Lucky Portia.) So Antonio, all of whose own capital is tied up in his shipping ventures, borrows money from Shylock, who waives the interest rate out of generosity because he’s lending to a Christian (Christians don’t charge or pay usury), charging instead a symbolic ‘pound of flesh’ …and we all know how THAT turns out for him.
Actually, it’s funny that you should have (mis)quoted Shakespeare to talk about misguided attitudes about lending, because his family’s experiences with lending and debt were far from fictional. In his day, although usury was officially deemed illegal by Christian teachings, moneylending was so crucial to the economy that Parliament got around the Bible by defining usury as charging more than 10% interest. Shakespeare’s father, a glovemaker, had to pay a fine when he got caught black-market lending. He had lent someone a small sum for a month and charged the equivalent of 80% APR. (!!!)
So when Polonius, the comic royal advisor in Hamlet, idealistically advises his son, “Neither a borrower nor a lender be,” you can be sure that not even Shakespeare’s audiences would have taken that seriously. Unless they were Puritans — who never went to plays anyway because they questioned the value of fiction.
P.S. I actually wonder whether people didn’t turn to U.S. bonds because they anticipated a rise in the yield (at long last). Bernanke certainly squashed those hopes. I’m kinda depressed that the Fed decided to keep the lending rate so low. 10-year Treasuries are not likely to get back up even to the 5% range for a long time. Bernanke’s motto is clearly “Neither a saver nor a bond investor be…”
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thanks for responding to this (kind of tongue-in-cheek) reference to fiction. were I to pitch a piece on this to a literary magazine, I’d have to explore the historical background of Shakespeare and, before him, the Psalmist, to create some prescient opinion about today’s economic climate. If you do anything on that (you seem to have the knowledge!), let me know, I’d love to read it! I’m afraid that my Shakespeare studies, while deep in college, are not very fresh today.
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Interesting article, though it missed a big issue under what’s at stake. The US pretty much can’t default on its loans – they’re in US dollars. However, it sure can create some very bad inflation paying those loans.
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Nice article. Definitely enjoyed your thoughts on the downgrade. Only time will tell what direction the US will actually go.
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What does this mean from a PF standpoint though? One of the things I wondered was should I be trying to pay off debt in the face of a possible default – the idea being that if interest rates went through the roof, I’d rather have the cash on hand than pay off my 6% student loans.
In another vein, would love to see an article on the doomsday analysts – Pretcher et al. – and their ideas about the market. Pretcher and student loan debt are the reason why I have all my money in savings and none in the market except my very small IRA.
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I don’t think it makes a difference for those kinds of questions – the general good advice of “First, have an emergency fund. Then, get out of debt.” is useful in any kind of economy – more when things are bad, or inflation is high, but necessary even when things are good in general because they protect against individual bad times.
it’s more of a question of personal finance in terms of investments – for God’s sake don’t sell low, like someone mentioned above. Don’t assume pension money is safe. Other than that, we could talk endlessly about what’s the best investment strategy in various markets and scenarios (and there are boards that do that)
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Wow, by the name, I’m really wondering if the poster on #17 is related to me.
Great post. I like it, I like it– keep ‘em coming.
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“Greek’s debt, as a comparison” – uh, do you mean “Greece’s debt”?
Interesting article, but would also like to see more connection as to effect on personal finance as noted by other commenters.
Also, what is Sarah Gilbert’s Blog called?
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Likewise, the Shakespeare quote was wrong — particularly sad since she gave a link to the scene! The full correct quote is “Neither a borrower nor a lender be; For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.”
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I do plan on doing future pieces on how this affects personal finance. My blog is cafemama.com.
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This was interesting and I’d like to see more like it. It’s an expansion of GRS material that I appreciate very much.
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Interesting piece. I like that it’s to the point and current.
Also, a question about her very last point:
“the austerity measures being taken by Congress will not help the American people or expand the economy. But it will make it easier to repay the debt.”
What austerity measures are you referring to (clueless here)? And can you clarify a bit? Do we (the American people) not want it to be easier to repay the debt? If we focus on expanding the economy does that eventually also make it easier to repay the debt? Is this one of the fundamental differences between the two parties right now?
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Cutting medicare, medicaid, and social security. People have a tendency to call these “entitlement” programs, but they are paid for by taxpayers – ie, we’re all paying into the system (check your paystub, it’s right there). But they are pretty expensive programs.
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Since it says austerity measures “being taken by Congress,” my assumption is that it is cuts in other areas. Part of the agreement was that the entitlement programs were not impacted–at least not yet. If they can’t come to an agreement by Thanksgiving, then Medicare payments to providers get cut, but no impact on recipients.
“Government cuts” can include anything from eliminating paving projects, maintenance, firing government employees (500,000 of the jobs lost have been government jobs–including state & local). All of these cuts mean fewer dollars in the economy. With an economy that is 70+% consumer driven, this is a problem.
Good, solid, easy to understand post; I’d like to see more of these.
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I’m not 100% sure – the Medicare websites are very difficult to read and comprehend – but my understanding is that Medicare is an insurance program.
So yes, when the government reduces its share of payments to providers – when e.g. a Medicare-covered treatment, formerly reimbursed at $1000, is now reimbursed at say $650 – that does indeed affect the Medicare-covered patient. Because s/he has to make up the difference in cost.
That’s the way regular insurance works, anyway. The less the insurance covers, the more the patient has to pay.
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To repay you debt you need to save some cash. That means no more 3rd pavings of the same highway in the same year. Less money for salary increases for public workers, etc.
With less money to spend, the private companies contracted by the government will earn less. That means less jobs, etc.
With that, the government needs to figure out a balance, so that the economy won’t completely shut down but they still are able to spend less to save more.
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Finally a meaningful article that actually answers some real life questions instead of endless “goodwill” posts.
Thank you!
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The quote attributed to Shakespeare was actually one he borrowed from a much older, wiser source Proverbs in the Bible.
Still to this day a very good source of wisdom, especially in regards to money and how to use it ‘properly’.
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I’m glad to see this article, it’s a topic that I’ve been thinking about as my retirement accounts plunge.
One thing I wish would’ve been mentioned is the impact on state ratings and bank ratings. USAA, for example, got downgraded as well (they have addressed that on their website). So even if it means “little” overall, what does it mean to those of us not emerged in the financial world? Should we be buying more stock? More bonds? Should we hold more cash? Expect interest rates to stay the same (low) values?
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Love that you have a woman’s perspective of the financial world. Coming from someone who was laid off of my job of 35 years back in 2008. Collected unemployment and worked a seasonal job to stay afloat.
I was wondering is this a good time sell my home?
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Sarah,
I enjoyed your article, but I thought it would have been even better if you looked at what happened to countries that have had their credit ratings downgraded. Did it force an interest rate increase? How much did they change? This could help put some perspective on how much of a difference the rating change actually means.
I agree the stock market is reflecting people’s worries rather than rational predictions of the real consequences of the downgrade.
-Rick Francis
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“I agree the stock market is reflecting people’s worries rather than rational predictions of the real consequences of the downgrade.”
-Rick Francis
“Holy ****, they downgraded treasuries?? Sell the entire portfolio and put me in treasuries!” – astute Tweet from the other day
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I also enjoyed the article, and as many others have said, would like a follow-up on how this will affect my savings and retirement.
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JD, congratulations on landing as a writer the founder of a site like WalletPop! She is clearly a force to be reckoned with, and as #8 Chris said, she writes clearly and plainly.
My best wishes for your mom’s stability. I am traveling 1500 miles this week to deal with my mother’s moving into an assisted living facility, and hopeful for a good result. Keep up the good work, and my prayers are with you and yours.
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I appreciate the perspective, however I have two points:
1) I like deeper content, but it can change the tone of the blog from people starting out to people further along their journey.
2) When you wade into current events emotions are more likely to run high and it’s hard to keep politics out of it simply because opinions on how to approach the issues are often diametrically opposed, divided down political lines When Democrat supporters say “increase taxes and benefits cannot be cut at this time” and Republican supporters say “decrease taxes and benefits must be cut at this time” it’s hard to find a middle ground.
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I like this style of article, feels like GRS is getting some fresh content. Lately things have been feeling a bit rehashed for too long.
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After Bernanke said yesterday at the FMOC meeting that the Federal Reserve would hold interest rates at zero until mid 2013 — two years from now! — it’s become crystal clear to me that savers are going to continue to get the shaft until the whole farce of our fiat currency comes to an end.
The only way to “live rich” is to be debt-free. No rolling over, no leveraging, no restructuring. No worrying about trying to make the interest payments (let alone worrying about trying to pay down the principal). Buy what you want or need with cash, and live on what you make. Eliminate the headache (or political dog-and-pony show) of trying to perpetuate the facade that it’s possible to live above your means.
In my opinion, living on debt deserves a “junk rating,” because it saps quality of live in exchange for mental stress. In the end, all your prosperity is an illusion, and sooner or later, you really feel that in the happiness department.
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I liked the article and would welcome more like it. Welcome Sarah.
My question to S&P is – where the hell were the downgrades when the mortgage backed securities were being rated? They were happily rating those AAA even though the mortgages underlying them were crap. All the ratings agencies are a joke and unnecessary – like Sarah said the market is the de facto rater of bonds based on what price they sell for.
I also find it odd that Buffett speaks out about the downgrade and then Berkshire Hathaway is also downgraded. What a joke.
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Berkshire Hathaway was not downgraded.
S&P downgraded several US financial companies from AAA to AA+ mainly because the US govt. was downgraded.
Berkshire Hathaway was not downgraded, it stayed at AA+ (though you might consider that
an upgrade, since by not being downgraded, it now has the same rating as the formerly higher rated companies.)
See:
http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245316596970
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It’s funny, I can buy the local Santa Rosa paper that ran a peice saying the S&P did the downgrade to be mean, and that they are irrelevant because of the math error. Or I can read a smart instructive article here for free. Needless to say I’m not supporting the local paper unless they turn around.
Also; S&P’s website has a rationale video that gets into debt/GDP as a key ratio in sovereign debt.
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I’m not quiet impressed that you shake your head at people who call junk bonds “junk” because when you were an investment banker you learned the oh-so-clever euphemism of “high yield”. The “time-honored risk/reward ratio, the more the risk, the better the reward” works, until it doesn’t. High risk doesn’t always mean more reward, sometimes it means you crash. Did all the junk bonds you sold lead to high returns for your clients or did some of them lose money?
“We young investment bankers almost felt we were cheating sometimes” … did it ever occur to you that maybe Wall Street was cheating. But Wall Street is not some autonomous being; it is run by people, and some of those people cheat. Do you know anyone who was part of the problem?
“If Ford were to declare bankruptcy and sell everything, after salaries and taxes were paid, the debt holders would be paid the principal they were owed, and then, last, the stockholders, who would probably get nothing.” Really? So bond holders don’t have any risk? The holders of the junk bond (I mean, “high-yield”) mortgage backed security got paid back their principal? Wow.
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One thing is missing. The claim is made by many that this was an entirely political move by S&P. Maybe. But the reality is that failure to service your debt (it’s always about servicing debt, not about paying it back!) is in most cases not economic necessity but the result of failed policy and messed up politics. Even the Greek example is telling. The Greek government would be perfectly solvent even now had it enforced the country’s very own tax code. It is estimated that the Greek government that way lost at least a hundred billion Euros which amounts to about 1/3 of the governments’s entire debt stock.
In the US, the question isn’t either about whether the country is able to service its debt. It clearly is. What however didn’t go down very well was that it took White House and Congress until the very last day to get a deal done that enables the government to pay its bills. Had the debt ceiling not been raised, the government probably would have continued to service debt but would have to stop welfare payments or salaries or cut other expenditures on a large scale. One wonders how long that would have been politically possible until influential figures would have asked to stop servicing the debt instead. The bottom line is: what is in question is the political will to service debt. You don’t let creditors wait until the very last day without taking a credibility hit. Therefore, the US downgrade is perfectly resaonable.
On a sidenote: The continued fall in interest rates on US (and some other countries’) debt is not a very good sign. It reflects the investors’ drive into safe assets. Or in other words: they’re fleeing other investments no longer deemed safe or profitable like stocks. This points to further economic slowdown. It also appears that some big American and European banks got into trouble. We may be heading for a fresh round of bailouts. That’s why everybody flocks into bonds. Of course, by now, their yields won’t even beat inflation.
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This writer is a great addition … we need someone who can take the complexity out of stocks and present the material in a manner we all can understand. Very timely, and I think many of us want to know more on the subject.
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There are a lot of people who really know very little about the markets who are pontificating and are fixating on the sky falling when it is not. Today’s conditions are far better than what caused the downturn in 2008 and we still have a VERY long way to go towards the Great Depression. Don’t use some BS analogies, or use homespun phrases, do some actual research on employment numbers (and how they are compared now vs then), GDP, and also realize that we haven’t been a manufacturing based economy for decades.
This too shall pass.
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Because they yields have gone down, for the time being it won’t mean much. That being said, I just read an article where 60% of the country supports raising taxes on the wealthy and slashing spending. While that’s a step in the right direction, they also don’t want any changes to the giant elephants in the room – social security and medicare/medicaid.
If we don’t reign in the entitlement spending a single downgrade is the least of our concerns.
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I really liked the article, i also agree that the rating agencies are usually behind the ball. In late 2008 and early 2009 the company i work for which is a highly profitable large company had problems lending money to pay short term debt, suppliers and employees. The credit rating at this point was A+. Eventuelle we were able to secure lending and also a large cash reserve and at the same time the credit market improved, we were again in a very stable possition….then came the down grades to A- and then B…..
I dont really think the rating agencies have much of a role to play in investments…
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Sorry, JD, but this post misses the mark I believe. It also doesn’t really fit with this (our) community and I hope you’ll give serious thought before endorsing (by publishing) a similar article.
The writer states: “the austerity measures being taken by Congress will not help the American people or expand the economy. But it will make it easier to repay the debt.”
How can you believe this? Isn’t that what our community is all about – spending less than we earn so that we can “Get Rich Slowly”?!
This is a community that embraces frugality and views debt as a 4 letter word. Miss Gilbert, however, seems to think that excessive spending and debt is OK…and even more beneficial for the health of the country.
Here’s a hint: if spending/debt doesn’t lead to prosperity for individuals…then it certainly doesn’t lead to a better outcome for companies or for countries/nations. That’s a fact. Kitchen-table economics friend.
Please be careful in your screening process of contributors…this is a wild card.
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I’ve always felt the main message of this blog is to strive for balance, not to obsess on one side of the equation. Sometimes the best way to reach that balance is to ask for a raise. Just some food for thought.
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there is a huge difference between personal debt and government debt. While I agree that striving toward a debt-free is very healthy for an individual, I don’t agree that the government should operate on the same principles. I am not now, nor have I ever been, a proponent of balanced budgets for government; I believe that the government’s role should be to provide *all* the services and support systems needed by its citizens, not just the ones that it can afford with current income. In fact, most economists agree that, in a recessionary period when revenues are down, government should be spending more than ever — economists across the political spectrum, I should add, agree on this point. Politicians on the political spectrum do not agree, though they have all been acting as if the economists are all wrong — that cutting programs is the best approach. I’d argue that policies undertaken by both sides of the government are flying in the face of economic theory.
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Truly enjoyed this fresh post and the topic.
As some have mentioned, delving into topics that involve politics can be difficult – we need to guard against becoming polarized here on GRS. This is one of the few blogs where we behave respectfully towards eachother. If I want hostility, I can find plenty of that elsewhere.
JD, very much enjoyed the post, and all of the comments as well. Lots of interesting perspectives.
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Probably the clearest and most informative article on bonds I’ve read. (And I work in a related area).
It was nice to have an article on current situations on GRS, and having such an informative article written by n expert in the area (rather than personal stories or self-confessed non-experts) was a refreshing change.
Welcome Sarah
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Sarah,
Awesome 1st article! I’ve been looking to learn more about the Financial Markets in general and how Economics work… I just hate being in the dark and feel like we’re being lead to a “financial ambush” that everyone else knows about, but we don’t.
This is great stuff and I’ll be returning to read more!
Mr Credit
ESPN Radio San Diego
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You asked if we’d like to see more current events related posts. Yes! What is happening out there is affecting all of us. And this post added something new. There are only so many ways to discuss saving at the grocery store.
Thanks – Well written and useful.
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I really enjoyed this article. I appreciate the way Sarah has successfully paired information and everyday language without dumbing everything down too much.
Thank you, I hope to see more articles soon.
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I am sorry to say that this article is slanted from a “sales” perspective. She made a great sales case for her selling her product, but unfortunately not much balanced knowledge of the whole.
She may have had the title “investment banker” but sales is sales.
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Susan, I’m confused — what do you think I’m selling? I’m no longer an investment banker and have no interest in getting Get Rich Slowly readers to buy or sell bonds of any sort (I just personally think high yield bonds are a relatively rewarding investment, given a corporate backer whose business I thought was generally positive). I don’t get a penny either way — the only thing I’m selling is words.
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I’m pleased to see that response to Sarah’s first article is generally positive. As I’ve been working with her behind the scenes today, I’ve learned more about her. Including: She’s practically my neighbor. Seriously. She lives about six or seven miles away, and I hang out in her neighborhood all the frickin’ time. She and I seem to share similar attitudes and philosophies. She writes well. She’s smart. In short, I think she’ll be a great fit around here.
For the record, I don’t intentionally bring on only women staff writers. That’s just the way it’s worked out so far. And in a way, I’m glad. Most of the PF world is filled with men writing about money, especially in the blogosphere. I like that GRS offers views from both sexes, and from a variety of life experiences.
Look for Sarah’s bio tomorrow, I think. It’s edited and ready to go, and currently scheduled to run at 11am Pacific.
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YES, yes, yes! Thank you for bringing women’s voices into the world of financial blogs. I’m so tired of men dominating that space, and most other blog spaces that don’t have to do with parenting, couponing, shopping, makeup, or cooking or home-making. It’s refreshing to hear from women on these important topics. And it’s wonderful that the platform you’ve created can be used to bring attention to women writers.
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The key action for every investor is to try and preplan ahead. The S&P downgrade wasn’t something out of the blue. It was widely discussed before they dropped the boom.
Basically, S&P is saying that the debts of United States now have political risk factored in. Our country has always been considered to be a stable political entity.
Investors didn’t have to worry that our sovereign debt will be declared illegal by a sudden military coup and change of dictator. However, our politicians now their campaign for reelection as a priority over the difficult decisions.
As a DIY investor, look at everything because with the electronic age, everything is inter-related now and will affect your portfolio.
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What a great article. I look forward to more from this author. It’s clear that she’s smart, and she has stuff to teach the rest of us from actually being in the banking industry. And she seems like a good writer. Some of the other guest authors ramble on and on without much to say.
Also, I appreciate how the author explained complicated stuff in an easy-to-access manner. I now have a better understanding of “junk” or “high-yield” bonds, and I’ll be more likely to invest in them in the future. Cool!
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