This is a serious development because, given that AIG carries an aggregate debt of about $180 billion, the downgrade will cost the company an additional $280 million annually in debt service, according to an A.G. Edwards estimate.

S&P credit analyst Grace Osborne said: "The number and scope of inappropriate financial transactions have diminished our assessment of management and its internal controls, corporate governance, and aggressive culture;The potential breadth of management involvement in these transactions raises broader enterprise risk-management concerns."

AIG can handle this downgrade and survive. That is not the real issue. The important point is that as aggressive managers ignore the signs of a destabilizing financial system in the world today, there will be referees like S&P, Moody's, and Fitches that rein them in.

Management at AIG might not like the result, but ;

Others might not like the tightening action of the Fed, but ;

Without checks and balances, some players run amok. And they do at times -- both corporate managers and investment managers.

I often refer to The Book of Ecclesiastes, Chapter 3, because I do hold the belief that "there is a time;" I also believe that what the ratings agencies are basically telling you and me today is that now is not the time to push an aggressive risk-oriented culture in business and investment.

I am not referring to whether the broad markets (debt, equity, or commodity) are over-priced (or under-priced) because that is not what is on my mind today.

Anyone with eyes can see that equity markets are confused: yesterday way up, the day before, way down, and so forth. The volatility indexes (VIX and VXN) are on the rise, which is historically bad news for bullish investors, and one has to question why.

Now there is not a day go by in capital markets that it couldn't be said that markets are confused; but this is different.

For two years, there has been wave after wave of buying of U.S. equities, but with each new round of buying, the U.S. Dollar has weakened. That is an abnormal state.

As I see it, there appears to be a massive move of capital out of the USA into other countries via Foreign Direct Investment, but I do not have the FDI figures at hand to illustrate it. But, at the same time, I am wondering why the Dow 30 leader board is always populated by the same ticker symbols, GE, BA, MMM, and UTX?

Yesterday there was an AP report that did hit on the issue:

"China's top leaders have pledged more curbs on surging investment, warning that excess spending on steel factories and surging prices for iron ore threaten the economy. The moves, announced by the government following a meeting of the State Council, China's cabinet, caused share prices on domestic bourses to slip early Thursday. China has been imposing curbs on bank lending and restricting investment in some sectors it says have been expanding at an unsustainable pace, risking financial problems, straining energy and transport networks and pushing prices dangerously higher. Investment in construction, factories and other "fixed assets," China's benchmark measure of capital spending, rose 24.5 percent in January-February compared with the same period a year earlier."

Where is this capital investment in China coming from if it is not from America's great capital goods manufacturing conglomerates, GE, 3M, Boeing, United Technologies, and from major consumer product manufacturers like GM, which have all reached the end of the line in their losing battle to control U.S. healthcare costs for their high-priced workers.

As I ponder markets this morning, I can see that the U.S. is the only advanced economy that was apparently growing rapidly in the 4Q04. It is a fact that Japan, Europe and Canada are experiencing severe slowdowns in their economic cycle. I have to wonder why the U.S. has been out-performing, and ask myself if it's a sustainable trend.

Liquidity is the issue. In the U.S., the Google phenomenon has pumped tens of billions into the economy. The Microsoft one-time dividend payout added tens of billions more. The U.S. selective market real-estate bubble (and associate cash-outs) has added tens of billions more. The share buy-backs by America's largest corporations have added tens of billions more. The change in the U.S. dividend taxation laws has added tens of billions more.

That is a lot of tens of billions of dollars.

Yes there have been many American jobs created in the past 18-months, but barely enough to cause sustainable economic growth at home. Unlike the U.S.-initiated and driven Y2K liquidity bubble, which recycled that excess into Silicon Valley, this time the capital has been aggregated and offshored to China, India, Russia, Brazil, etc.

What Americans have created, in terms of liquidity, others are now enjoying. This liquidity is not showing up in retail sales at home, or higher U.S. stock prices, and so forth. Some of it has gone into U.S. bonds " both government and corporates -- which has pushed down yields, and served to extend the real-estate bubble.

The fact that the spread between high quality U.S. Treasuries and much lower quality corporate bonds is so narrow is amazing to me. This is a sign that investors are ignoring risk, and paying much less attention to the importance of the independent rating agencies than they ought to.

Tomorrow, the U.S. Jobs Report will be published, and I will be looking for an increase in manufacturing jobs. Without that, I believe the 4Q04 growth in the U.S. economy is not sustainable, and is being artificially supported by financial engineering of the kind that the S&P Ratings service is now concerned about with companies like AIG.

Should investors not start applying a risk premium to equities, and to lesser quality credits in the bond market; then I believe that further tightening by the Fed is in order, and equity prices are headed much further south.