Money Rehab with Nicole Lapin - The United States' Credit Score Takes a Hit— Here's What Happens Now

Episode Date: August 25, 2023

Earlier this month, the United States did not ace its credit test. To unpack this story, and give a bonus insight as a recovering finance bro, Nicole talks to Shawn O’Malley, the chief editor and creator of the popular investing newsletter We Study Markets. Subscribe to Shawn's awesome newsletter We Study Markets here: https://westudymarkets.beehiiv.com/ Want to start investing, but don't know where to begin? Go to moneyassistant.com and meet Magnifi, your AI money assistant, designed to help you make a plan for your financial goals. Want one-on-one money coaching from Nicole? Book a meeting with her here: intro.co/moneynewsnetwork 

One of the most stressful periods of my life was when I was in credit card debt. I got to a point where I just knew that I had to get it under control for my financial future and also for my mental health. We've all hit a point where we've realized it was time to make some serious money moves. So take control of your finances by using a Chime checking account with features like no maintenance fees, fee-free overdraft up to $200, or getting paid up to two days early with direct deposit. Learn more at Chime.com slash MNN. When you check out Chime, you'll see that you can overdraft up to $200 with no fees. If you're an OG listener, you know about my infamous $35 overdraft fee that

I got from buying a $7 latte and how I am still very fired up about it. If I had Chime back then, that wouldn't even be a story. Make your fall finances a little greener by working toward your financial goals with Chime. Open your account in just two minutes at Chime.com slash MNN. That's Chime.com slash MNN. Chime. Feels like progress. Banking services and debit card provided by the Bancorp Bank N.A. or Stride Bank N.A. Members FDIC. SpotMe eligibility requirements and overdraft limits apply. Boosts are available to eligible Chime members enrolled in SpotMe and are subject to monthly limits. Terms and conditions apply. Go to Chime.com slash disclosures for details.

I'm Nicole Lappin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab. Earlier this month, the United States did not ace its credit test. To unpack this story and give us bonus insight as a recovering finance bro, I'm talking to Sean O'Malley, the chief editor and creator of the popular investing newsletter, We Study Markets. Let's get into it. Sean O'Malley, welcome to Money Rehab. Hey, thanks for having me. Earlier this month, Moody's cut the ratings of 10 banks and named six large banks as potential downgrades. This is a story really, I think, worth breaking down for the Money Rehab audience.

So first, for any listeners who don't know, can you introduce them to Moody's? Yeah. So Moody's is one of the three major credit rating agencies. So you'll hear that get thrown around a lot. And the other two are S&P and Fitch. And the role that they serve is basically just rate companies and governments' financial health. And so investors rely on them for sort of providing a barometer of, okay, how risky is this investment? If we're going to lend money to Apple or the US government, all of those entities get a credit rating from those big credit rating agencies. It's something that is maybe a little bit in financial jargon, and most people are probably

not paying attention to what the ratings agencies are doing. But from sort of a plumbing of the financial system perspective, they're really important. That can give you a really quick, okay, they have a triple A rating, so they're probably going to pay back their debt and there is not a lot of financial risk there. Whereas a lower rating obviously would tell you there's more risk. Yeah, I would love to get into the rating system. I have seen a ton of memes by like finfluencers out there being like, yeah, you give me a credit score, you should get one too. Well, the United States does. And that's essentially what this is.

So this is also on the heels of Fitch downgrading the credit rating for the United States from triple A to double A. That is not an upgrade. That is a downgrade. But I think it's helpful to just walk us through the rating system. What are the grades? Yeah. And I think you put that really well. But I mean, the basic way the rating system works, it goes AAA, AA, single A, BBB, BBB, single B, CCC, and so on. And then it ends at D,

which basically just sends her in default. So definitely do not want to be in D. But it's really similar to basically the credit score that we all get. And it's not want to BND, but it's really similar to basically like the credit score that we all get. And it's this sort of barometer, like I said, of financial health. And, you know, honestly, there's a kind of important question here of how much does it matter? It's kind of like, you know, is it really a big difference if you have a 750 credit score or a 770 credit score? So, you know, to what you alluded to a little bit there, this US government downgrade, yougrade, how much is a matter to go from, let's say, a perfect AAA to the second highest, which is a AA plus.

And then in between those main letter grades, there's these plus or minuses that are sort of a AA plus is better than a AA and a AA minus is a little bit better than a AA. And you can really get into the weeds into it. But like I said, it's really just a nice barometer of whoever's looking to borrow money, their financial health. Yeah, we had the CEO of FICO on the show and he said he didn't have a perfect credit score. I think he said his assistant had a better credit score than he did

because it's about financial habits and not necessarily about wealth. So how you pay your bills back on time or not. And it kind of works the same way for governments. The United States isn't the only country that has a credit rating. That's exactly right. Yeah. So the ratings agencies, I mean, everywhere from your local city that you live in to state governments, federal governments all around the world, companies, they all get credit rating agencies. And it's a great business to be in because everybody needs your rating and you kind of have this, you know, there's three of them. So there's almost this oligopoly on being able to provide those ratings.

And when you're investing in international markets, the acronym PIGS comes up with Portugal and Greece and Spain and kind of talked about within the financial world as lower credit rated countries. And so those types of countries that have had financial issues will have triple B or lower. And you also mentioned corporates have credit scores as well that follows the same rubric. Yeah, that's exactly right. And so you think of what the hierarchy of credit ratings might be. There's actually only a few companies in the US that have a perfect AAA credit rating. I think last I checked, it was Johnson & Johnson and Microsoft. So it's kind of funny now to think that I think Johnson & Johnson has a better credit rating than the US government. And it's funny, too, because we have a lot of states now that have better credit ratings than the US government. I live in Virginia, and Virginia has a triple A credit rating. But now the US government has a double A credit rating. And it seems kind of absurd that there could be that divergence there. Yeah, I think at the margin, it doesn't totally matter. But if there's a big downgrade, then that's a big deal. But it works the same way

as a personal credit score works, right? Like a seesaw, you know, the higher the credit score, the lower the interest rate and vice versa. So if you're going to go invest in Portugal or some shitty company, then you're going to want more interest in exchange for taking that risk on, right? Yeah, that's exactly right. And so, you know, as you said, the higher rated companies or governments that are issuing debt and trying to raise money from investors, you're going to give them a lower interest rate, you know, as you said, the higher rated companies or governments that are issuing debt and trying to raise money from investors, you're going to give them a lower interest rate, you know, if they have a high credit rating, because they're seen as being a really high likelihood to pay back their money. It's similar to if you went to get a mortgage or an auto loan,

and maybe you have a lower credit score yourself, you're going to get a higher interest rate because, you know, the person or bank, whoever it is lending you money, thinks, okay, there's more risk here. And as that kind of cliche phrase in finance goes, with more risk comes more return. And so, yeah, if people think that you're not as likely to pay back their money, kind of counterintuitively, they charge you a higher interest rate and make it harder for you to pay back your money. But I digress. No, you don't. It's a really important point. And we saw this when all the government debt ceiling stuff was going on. Treasuries rose,

which are bonds issued by the U.S. government. So the interest rate became higher because there is I mean, let's be honest, the United States is not going to collapse. And so if we would have much more armageddon issues, if that were the case. And I don't think anyone would be cashing in their treasuries at that point. But we saw bond yields go up because of that, right? Like the inverse effect. Yeah. And that's kind of a good rule of thumb. And so bond prices and yields have this inverse relationship. So if people are worried and they're selling off bonds and the yields are actually going to rise, and that's something that we saw happen with this whole May debt ceiling kind of fiasco that happens every few years. You're sort of structurally undermining the

trust that people have in their government. If this thing that we might take is really holy or sacred, our federal government, and this is what's running the country. And then they can't even pay their own debts as a household or an individual or a company. What are the ramifications of that? And it's a self-imposed wound. There's really no reason why the US government shouldn't be able to pay back its debts. And that's something we talked a lot about in the newsletter this May. It's really this congressional argument of every year, every couple of years, they take it down to the wire and it's this big debate of, should we raise the debt ceiling? Should we not raise

the debt ceiling? But ultimately, as long as you're able to raise it, there's going to be demand for basically lending the US government money that it can use to pay down its debt. So technically, there's no reason they shouldn't be able to, but when you get into these partisan standoffs, that really hinders people's trust in the government as an institution. And I think we saw that reflected with this most recent credit downgrade. But it's also not the first time that the U.S.'s debt has been downgraded either. for why these ratings matter. You know, at Money Rehab, we're all about the retail investor or a newbie investor. Why are these ratings important if I'm just starting to invest and how do I find them?

Yeah, well, you know, I would probably say for the average person, they don't matter a ton. I know that I didn't look at credit ratings a whole lot. It's really more for, let's say, on the bond investing side, people that are trying to determine the likelihood of paying back debt, whether a credit rating matters.

But of course, when you, let's say, looking at stocks to invest in, you want to be mindful of how profitable and how financially sound that company is. So you can probably draw a pretty strong correlation between blue chip companies with really sound finances are more likely to be a better steward of your money. And when you think of it, and this is kind of the Warren Buffett way of thinking about investing, but when you really think about it, that you're buying a stock, you are trusting a company to manage your money for the long term, and you're taking an ownership stake in that business. And so when you take that kind of partnership and build that relationship

with a company, you want to make sure that they're financially sound. And so the credit ratings are really great way to assess that. And like I said, this kind of financial barometer buzzword I keep throwing around, it's a good way to think of it. You shouldn't just say, I'm only going to invest in triple A companies. Those are the ones with the highest credit ratings, because obviously there's a lot more to consider, but it's a factor to be mindful of. And there's this cutoff when you think about credit ratings between what's called investment grade, which is higher than triple B, triple B and above. And then below that is basically called junk. And it doesn't mean that all of those investments are junk, but it kind of, again, is a signal

telling you that, okay, a company with a junk-rated credit rating below that BBB cutoff is probably not as financially sound. There's some sort of structural, economic, or business risk that might be weighing on them. And it's just something you want to be mindful of. And so you should probably try to expect a higher rate of return from that. And if you invest in a more risky junk rated company, and it's reforming just as well every year as, let's say, Apple, which is one of the highest credit ratings, you should probably just own Apple because you're taking a lot fewer of those other

business and financial risks. And just to do a quick dictionary note, And just to do a quick dictionary note, as we call them, blue chip companies being like the best, most sound companies out there. We just try to unpack the jargon. Yeah, no, so I think that's really important. And I try to be pretty good about unpacking the jargon too, but sometimes it slips out. For sure. It's a whole other language. But there was this arbitrage, And I think we've defined that on

the show before when all this fiasco was happening in Washington. I kept saying like, no, it's not a time to sell bonds. It's time to buy bonds. I bought a bunch of bonds because yields were awesome because all of a sudden they became higher based on this. But the likelihood of the U.S. not paying back was like negative. So I thought it was a great buying opportunity. I think so too. Yeah. And especially for the first time in my living memory, and I think a lot of adults living memory, you can actually get a half decent return on cash, which is kind of awesome. I grew up almost thinking that you had to be invested in stocks if you were ever going to, let's say, hit retirement or save for any future goal, because you're working so hard to save your money, and then you're looking at a 0.1%

interest rate. That's just so discouraging. And everything you learn about compounding your investments kind of goes out the drain when you don't have a decent interest rate. And to your point, we saw this spike in interest rates on treasury bonds at the US government issues, especially around the time of this whole debt ceiling fiasco earlier this year. And they've actually continued to rise because the Federal Reserve has kept pushing rates up to fight inflation. But, you know, you can buy one-year treasury bonds or three-month treasury bonds that are

paying, you know, 4% to 5% interest rates. And especially as inflation comes down, that real return, which is the difference between, you know, the interest rate you're getting and the inflation rate, that becomes more and more meaningful to everyday people trying to save their money. Like inflation adjusted. Exactly. Hold on to your wallets. Money Rehab will be right back. One of the most stressful periods of my life was when I was in credit card debt. I got to a point where I just knew that I had to get it under control for my financial future and also for my mental health. We've all hit a point where we've realized it was time to make some serious money moves. So take control of your finances by using a Chime checking account with

features like no maintenance fees, fee-free overdraft up to $200, or getting paid up to two days early with direct deposit. Learn more at Chime.com slash MNN. When you check out Chime, you'll see that you can overdraft up to $200 with no fees. If you're an OG listener, you know about my infamous $35 overdraft fee that I got from buying a $7 latte and how I am still very fired up about it. If I had Chime back then, that wouldn't even be a story. Make your fall finances a little greener by working toward your financial goals with Chime. Open your account in just two minutes at Chime.com slash MNN. That's Chime.com slash MNN.

Chime. Feels like progress. Banking services and debit card provided by the Bank Corp. Bank N.A. or Stride Bank N.A. Members FDIC. Spot me eligibility requirements and overdraft limits apply. And now for some more money rehab. Talk about writing a book when interest rates were at zero. And I talked about how savings was the CDs were bonds were black. You have to invest in stock market. Now I'm like, do I have to go back and rewrite these books based on interest rates changing as you and I grew up at a time where they were on the floor artificially? So that's not how it has been historically,

but I'm like, I have to rewrite Rich Bitch. It changes everything. I know. Yeah. I mean, I haven't written a whole book, but I've definitely written articles and things in the past where it's like, even just like thinking about the discount rate and the rate of return that you could reasonably get by investing in the stock market or just towards any of your savings goals, a lot of that has been pushed up. And so for all the big picture stuff, we talk about chaos at the treasury market and debt ceiling standoff and all of this kind of political and big picture macroeconomic drama that's unfolding. I think the really simple takeaway that you made is for most people, bank savings rates and rates they can get on bonds are, for the first time in their

lives, really meaningful. And that's a profound thing. And it comes with this weird trade-off where you may be kind of crimping economic growth. The US economy has actually stayed pretty strong this year, despite the Fed raising interest rates a lot last year. But at least in theory, raising interest rates is supposed to slow the economy and result in more job loss. But it also means that you can save more money. Yeah, for sure. And you can get more than, you know, you and I have talked about for years by putting your money in a savings account. And that's the calculus that, you know, ideally, folks would have a baseline of financial literacy to be able to change based on these factors like interest rates and inflation. But yes, it's a major, major shift as you're planning out finances.

Off my soapbox, we talk about this literally every day. Okay, let's double click though, Sean, on the downgrade part of this. So to put it simply, the banks got the downgrade because of funding risks, lower profitability, maybe like ghosts of SVP crash past. Can you unpack it a little bit more and what's going on with the banks? Yeah. So this spring was really an eventful time kind of looking back. May, we were talking about this debt ceiling standoff. But if you flashback a couple months before that in March, we had this whole Silicon Valley Bank, First Republic bank blow up. And that really put the banking system on a lot of people's radars for the first time in, I don't know, 15 years since the great financial

crisis. I don't really think big banks or even small banks were on people's mind at that time. But really, my takeaway from that fiasco is that it opened people's eyes to we live in a digital era. And that sounds so obvious, and I hate saying it because it sounds so stupid to say, but really, I think for decades, we'd had this kind of reality where people had these long-term relationships with their banks. And especially living in a small town, you have the local bank franchise, and you go down to the store and you get a small business loan, or you get a mortgage, and kind of this quintessential American dream. And people would, I know my parents,

and certainly my grandparents, pretty much use the same bank their entire lives. And what happened with SVB is, I think you said funding, and that's exactly what the problem was. These banks fund themselves by deposits. And so if they know that you're most likely going to be a bank customer for 5, 10, 20, 30 years, a whole lifetime, whatever, that gives them a lot of flexibility with how they can invest and lend out money. And ultimately, that allows them to basically be more profitable if they can lend money for longer periods of time. And this whole SVB fiasco revealed that, okay, like I said, the digital era is here and people do not have loyalty to their banks. I have multiple bank accounts on several apps on my phone, and I would easily just take money out of one account and put it in another account with a couple clicks

of a button just to earn a higher interest rate. And I have no lasting loyalty to any of the banks that I've probably ever banked with. And the result of that was that a whole lot of people took out their money in 20 or 30 minutes. And so a bank run that might've previously ran over two or three weeks or months happened in the time span of a weekend or even just a few hours. And so that really reduces the response time that banks have to these quote unquote bank runs where everybody's trying to withdraw their money at the same time. And so as we move forward a couple months, it seems like the worst of that panic has kind of passed.

But really the takeaway is, okay, banks are in this new regime, right? They can't expect that people are going to have the same type of loyalty that they always did. And if there's less loyalty and there's less trust in the bank, or people can more easily withdraw their money, the result of that is banks probably have to lend on shorter time horizons and be a lot more conservative. And that also means they're going to be a lot less profitable. And so that's really why I think you saw a lot of these, especially these small and mid-sized banks get downgraded is because their prospects for being profitable in the future, people realize that that's really just a lot different now. And then you add in the fact that there's speculations

of a recession in 2024, and probably some more regulations coming as a result of the Silicon Valley banking crisis, where regulators are probably going to tell banks that they have to kill more capital against the loans they make. And to kind of break through the jug in there, that basically just means they have to lend less, to my point of them being more conservative. So banks are probably going to be a lot less profitable in the future. And if you're not one of the big, too big to fail banks, that's sort of backstopped by the government. You have some really tough questions to answer going forward. Yeah, thank you so much for following the money trail and how that credit rating or downgrade affects a person. Because it does just going in to get a loan. And this is not

breaking news. Banks do not just keep your money in beautiful little bundles in the vault in the back. They're using your money that you deposit. If I can say a little bit about myself, I started out studying finance and I thought, oh, I know how the financial system works. I studied finance. I'm a genius with money and kind of that college arrogance. But then I realized, okay, there's a lot of really practical things I don't know about the real world, even though I had, let's say, a finance degree. I don't really know how banks work. I don't know how to get a mortgage. I barely even know what the term mortgage means. And there are a lot of these really basic questions about

economics and finance that I struggled to connect the dots for. And I think a lot of people probably feel that way. And I know I was too afraid to ask questions that seem so obvious, like, okay, wait, how does a bank work? We hear this term like fractional reserve banking, but what does that actually mean? And to your point, they're taking your money and they're lending it out. They're not just keeping it. And so I feel like for the last five or six years of my life, I've been on this journey just to answer as many of those obvious, dumb questions and follow the rabbit hole as far as I can. So I can feel like, okay, I really understand. This is what banks are doing with my money when I give it to them.

And I don't think everybody cares about that. But as a fellow finance nerd, I find it really interesting and it really helps me shape the world around me and feel like I understand what's going on. I have taken a lot of pleasure with trying to explain those basic questions, those dumb questions that I've spent so many hours researching myself to share those with other people. And thank you so much for doing that. Obviously, a man after my own personal finance nerd heart. And thank you for also being vulnerable about that. Studying finance doesn't mean you're a finance genius.

It takes a little time, I guess, to realize that and some humility. But I think that's an important thing to say. They're not dumb questions. You literally paid to make your brain supposedly smarter about finances. And these basic concepts aren't taught to any of us. It's really frustrating and disappointing that the mainstream financial world is so exclusionary with the jargon and language they use. And I don't know what that is, but when you actually get pretty deep into studying finance

and economics and money, you realize that a lot of the things they're talking about are really simple. These are not crazy abstract concepts, but when you string along a series of the things they're talking about are really simple. These are not crazy abstract concepts, but when you string along a series of jargon, it sounds like you're saying something really intelligent when actually you're just saying, when borrowing a loan for a car is cheaper, more people are going to do that. It's like, oh yeah, when you said it like that, it's a lot more obvious. And I know too, with my own self, I used to take a lot of pleasure in feeling like I was invested in these really fancy things. It's like, oh yeah, I got this finance degree and

now I'm invested in Southeast Asian and I'm invested in their stocks or I'm invested in bonds from Eastern Europe, whatever it is. And it's like, I would do these abstract things. And then I realized like, okay, I'm just losing money because I don't really know what I'm doing. And it would be way more simple to just buy Apple stock, buy treasury bonds, do the S&P 500 index fund, all of that really basic stuff. And I realized like, okay, I'm investing almost for my own ego. I kind of like how it feels to be able to tell people that, yeah, I had in uranium. And people are like, wow, what?

I didn't even know you could do that. And I'm like, oh yeah, I did it. And I lost 20% on it, but I did it. And so I don't know, from the exclusionary jargon to maybe appealing your own ego, there's so many traps that I think the financial world can kind of put you down and really just comes out of keeping things simple and just being honest with your learning and what you want and your goals and all that good stuff. So Sean, are you a recovered or recovering finance bro? I think I am. I think I am a recovering finance bro. Yeah, I had a super traditional

finance job and I was doing, God forbid to say it, the CFA, which stands for Chartered Financial Analyst. And I passed the level one and I was really proud of that. And I was like 300 hours of studying and all of that stuff. But it's like like, basically it's just an exam that teaches you how to speak Wall Street. People ask me, what was it? I was like, I spent 300 hours learning how to be a finance bro, learning how to use jargon that makes me seem smarter than you or however you want to think about it. So I spent so much time thinking that I was so smart and so savvy because I was working at some big finance company or doing the CFA and all that good stuff. And reality, I realized that I was just kind of feeling my own ego and I wasn't really doing myself any favors.

So I think recovering finance, bro, is a good way to put it. Yeah. And those tests, I went through the CFP ones. I mean, you also don't use them. They're not practical. Like you have tools and terminals or whatever to do that. I would say everyone will pay the same amount at the School of Hard Knocks because that's literally the only school I've found that teaches personal finance, a finance bro, and your favorite former poetry major. We spent the same amount on that part of our brain.

We spent the same amount on that part of our brain. So former finance bro, I end our episodes by asking our guests for one piece of money advice listeners can take straight to the bank. So do you have just one? I know you have a zillion, but you just have one tip that money rehabbers can use to invest, say for retirement budget. Yeah. I mean, I think this is a big theme for your show and I'm going to steal this from Warren Buffett, but I think the best investment you can make is to invest in yourself. So keep listening to Money Rehab. Maybe read my newsletter, find great books to read. And just 30 minutes a day of really dedicated and focused learning will compound, to use a finance term, maybe it'll change your life. For the last five years, that's been my goal to do at least 30 minutes. Fortunately, I've been able to normally do more than 30 minutes a day, but at least 30 minutes a day of just really deep learning about something you're not familiar with, and that will compound and it really will change your life. And Warren, I'm just in my mind, we're on a first name basis. Warren also said in his own will to

his wife to put a majority of his money in low-cost S&P 500 index funds. Not like credit default swaps or Portuguese bonds or whatever. Exactly. Exactly. And not uranium or whatever it is. Just put in that S&P 500 or maybe diversify a little bit, but that's a pretty good starting point. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Lavoie. Our researcher is Emily Holmes. Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehabatmoneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content.

And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.