Stock Market Drop Not Caused By Credit Rating Downgrade?

It wasn't solely caused by the downgrade, but the downgrade did have an effect. He makes a good point about the rate on T-bills, however, that is more indicative about how the bond market is responding to the information. While bond traders/investors may be behaving like nothing has changed in their opinion of the U.S. economy, regardless of what S&P says, equity traders/investors are using it as PART of a signal that they should be getting out of the market.

The way I look at it is this, many people knew that the U.S. debt/economy issues were a problem. Now those people know that EVERYONE else knows as well and are trying to get out before the stampede to the exit, which (ironically enough) results in a stampede to the exit.

Think about it like this. You have all of your money in a bank. It is the biggest bank in the town, and is giving the absolute best returns. You realize that there are some major problems with the bank that could jeopardize it (for instance, that it is really a Ponzi scheme), but it keeps shelling out those returns. You know that as long as folks keep making those deposits you SHOULD keep getting your returns. You know that eventually it could come tumbling down, but you THINK that if you time it just right you should be able to get out before it goes bust.

Now, here is the thing. You are not the only depositor in the bank that knows this. MANY MANY other depositors know this, as well. You are all playing the exact same game of maximizing profits with the intention of pulling out before EVERYONE ELSE finds out.

Then along comes the local newspaper that puts out a story talking about all of the problems with the bank. The story doesn't contain any additional information, but now YOU KNOW that EVERYONE ELSE KNOWS about the bank. You run down to the bank the next morning to pull out your cash and guess what you find. All of your other fellow depositors are there too trying to get out before there is a run on the bank, which creates a run on the bank.

Now, whereas the bank collapses in this scenario, I do not believe that the U.S./World Economy will completely collapse. However, I do see the strong possibility of a large scale revaluation of equities markets that could put a long term dent in its perceived value. Translation: I think that it is going to take a while for the markets to completely regain the value lost over the past two weeks.