Nothing Will Ever Be AAA Again


We assume that you, like everyoneelse, have been madly dumping Treasuries now that S&P has downgraded them. Smart! And presumably in your flight to safety you’ve been buying AAA rated corporate bonds, from let’s say XOM or MSFT. Which are obviously safer than Treasuries because, while sure the U.S. Treasury can print dollars and Microsoft and Exxon can’t, Microsoft can always send out a secret electronic signal that makes your Windows crash 100% of the time instead of the steady-state 20%, which will force you to upgrade to the next version, which is pretty much the next best thing to printing money. And if XOM is short on cash it can just start a war in the Middle East (that’s how it works right?).

So you think you’re in pretty good shape right? Not so fast – your shit is still really AA+.

The problem is that S&P this morning downgraded Depository Trust Company to AA+ in sympathy with the sovereign downgrade:

The widely anticipated cuts were a direct result of S&P's downgrade of the U.S. sovereign debt rating on Friday. The clearing firms, which hold vast quantities of U.S. Treasurys as collateral against outstanding trades, previously have been put on negative watch by credit raters after a similar view was applied to the U.S.

S&P cut ratings by one notch for the Options Clearing Corp. and Depository Trust & Clearing Corp.'s Depository Trust Co., National Securities Clearing Corp. and Fixed Income Clearing Corp. units. The OCC handles all U.S. stock-options trade, with the DTCC units back up trading in U.S.-listed shares and government securities.

In a statement, S&P officials said the cuts reflect "potential incremental shifts in the macroeconomic environment and the long-term stability of the U.S. capital markets as a consequence of the decline in the creditworthiness of the federal government," S&P said.

The downgrades aren't the result of any company-specific event, according to S&P, and the firm hasn't changed its view of the fundamental soundness of their depository or clearing operations.

We love DTC because it’s pretty much the largest thing in the world, with custody of $34 trillion in assets. Among those $34 trillion in things are pretty much all corporate bonds. We’ll let Microsoft’s prospectus explain how this works:

Upon the issuance of each global security, DTC will credit, on its book-entry registration and transfer system, the respective principal amount of the individual beneficial interests represented by the global security to the accounts of participants. Ownership of beneficial interests in each global security will be limited to participants or persons that may hold interests through participants. Ownership of beneficial interests in each global security will be shown on, and the transfer of those ownership interests will be effected only through, records maintained by DTC (with respect to participants’ interests) and such participants (with respect to the owners of beneficial interests in the global security other than participants).

So long as DTC or its nominee is the registered holder and owner of a global security, DTC or such nominee, as the case may be, will be considered the sole legal owner of the debt security represented by the global security for all purposes under the indenture, the debt securities and applicable law.

All payments on the debt securities represented by a global security registered in the name of and held by DTC or its nominee will be made to DTC or its nominee, as the case may be, as the registered owner and holder of the global security.
We expect that DTC or its nominee, upon receipt of any payment of principal, premium, if any, or interest in respect of a global security, will credit participants’ accounts with payments in amounts proportionate to their respective beneficial interests in the principal amount of the global security as shown on the records of DTC or its nominee. We also expect that payments by participants to owners of beneficial interests in the global security held through such participants will be governed by standing instructions and customary practices as is now the case with securities held for accounts for customers registered in the names of nominees for such customers. These payments, however, will be the responsibility of such participants and indirect participants, and neither we, the trustee nor any paying agent will have any responsibility or liability for any aspect of the records relating to, or payments made on account of, beneficial ownership interests in any global security or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests or for any other aspect of the relationship between DTC and its participants or the relationship between such participants and the owners of beneficial interests in the global security.

In other words if you own Microsoft bonds (1) you don’t own Microsoft bonds, DTC does – you just have a certificate from DTC saying that they own those bonds on your behalf, and (2) Microsoft takes no responsibility for DTC paying you any of the interest or principal that it pays DTC. So if DTC decides not to pass the money along to you, you’re out of luck.

This is not a real problem of course as there are a whole lot of systemic/legal/etc. safeguards in place to make sure that DTC doesn’t take its $34 billion in assets to Vegas. But according to S&P, DTC is now more likely to default than Microsoft is – which means that your likelihood of getting paid back on a Microsoft bond is lower than the likelihood that Microsoft will pay you back. (I know!)

Ah, the joys of a world where AA+ is the new AAA …

UPDATE: S&P Cuts Ratings Of Major US Clearinghouses [WSJ]

DTCC Media Statement on S&P Credit Rating Revision on Clearing Subsidiaries [DTCC]