U.S. Credit Rating Is Downgraded – What Does It Mean

Lady Liberty Crying For Fiscal Sanity

The United States has been downgraded, which means there are questions as to whether or not we can pay our debt, at least in the long term. This could lower our credit rating and increase our borrowing costs.

One of the premier rating agencies, Standard & Poor’s, has reduced our credit rating from a AAA rating to a AA+ and released the following statement – “The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” the agency said about the move, which was announced after the markets had closed.”

John Chambers, the head of sovereign ratings at S&P, told CNN that the political brinkmanship over the debt ceiling proved to be a key issue, with “the U.S. government getting to the last day before they had cash-management problems.”

U.S. Treasury officials received S & P’s analysis Friday afternoon and alerted the agency to an error that inflated U.S. deficits by $2 trillion, said an administration official, who was not authorized to speak for attribution. S & P said it did not matter and they were continuing with the downgrade.

Chambers defended his agency’s move. “It doesn’t make a material difference,” he said. “It doesn’t change the fact that your debt-to-GDP ratio, under most plausible assumptions, will continue to rise over the next decade.”

This is the text of S & P’s release-

“The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.” What to expect on Monday: ” it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021.” And why all those who have said the downgrade will have no impact on markets will be tested as soon as Monday: “On Monday, we will issue separate releases concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors.”

Moodys has downgraded us to “negative,” which could mean they will downgrade us as well.

Undoubtedly, the blame game will begin immediately, but the fact is that this President has presided over the first downgrade in U.S. history. Since 1917, the United States has held the highest rating, albeit, not always deserved.

Ironically, the rating agencies, including S & P, supported the credit swaps which brought about our housing crisis. Despite this, they hold tremendous weight and their opinion will likely cause higher interest rates on our debt – we borrow $4 billion a day. It will be the cause of increases on all loans that we as Americans take out for cars, mortgages, and other purchases.

Monday morning Treasury bond yields should be interesting. Municipal bonds need to be watched since they use Treasury securities as backup. The FDIC will now clamor for more money. Interest rates will likely go up because they are technically riskier. Long term interest rates will rise. Mortgage interest rates increasing will further hurt the housing market. Asset prices falling will cause some banks to fail if they have a tight asset to debt ratio. The dollar will fall somewhat since other nations  have kept their AAA rating. Gold should see an uptick.

Was the declining stock market reacting to information they had about our drop in rating? If not, we should see a worse drop on Monday.