Five Things You Should Know About the S&P Downgrade

On Friday night, Standard and Poors announced that it was downgrading U.S. long-term sovereign debt from AAA to AA+, the first such downgrade in U.S. history.

Here are five things you should know about the downgrade — four important, one trivia.

1. S&P downgraded U.S. debt not only because of the deteriorating fiscal outlook, but also because of concerns about America’s ability to govern itself. It said:

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.

2. Moody’s and Fitch recently reaffirmed their AAA ratings on U.S. sovereign debt. On Tuesday, Moody’s reaffirmed its Aaa rating, but assigned a negative outlook given the risk that the U.S. might flinch from further fiscal tightening, borrowing costs might rise, and the economy might weaken. Fitch similarly reiterated its AAA rating on Tuesday, but noted that it would have a fuller reassessment by the end of August. Fitch also emphasized the need for further fiscal adjustments.

One issue (on which I haven’t seen much discussion) is how the impact of a downgrade would increase if it spreads from just one rating agency to two or three.

3. In the past thirty years, five nations — Australia, Canada, Denmark, Finland, and Sweden– have regained a AAA rating after losing it. See, for example, this nice chart from BusinessWeek:

America still has much to learn from other nations that fixed their economies and budgets after financial crises. Sweden, for example, did a remarkable job addressing the fiscal challenges that followed its financial crisis in the early 1990s.

4. This downgrade may set off a cascade of further downgrades for other U.S. debt. The federal government provides an implicit or explicit backstop for many other debt securities. For example, the federal government stands behind trillions of dollars of debt and guarantees issued by Fannie Mae and Freddie Mac, GNMA securities, and securities backed by guaranteed student loans. It implicitly stands behind systemically important financial institutions. And it provides substantial support to state and local governments. S&P did not specifically address these other credits in Friday’s report, but did say that:

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.

S&P did reaffirm its highest, A-1+ rating on U.S. short-term debt, which should limit impacts on money market funds and other short-term lending markets.

5. S&P was not the first rating agency to downgrade U.S. sovereign debt. In the category of trivia, China’s Dagong credit rating agency downgraded U.S. credit to A with a negative outlook earlier this week. Dagong had initiated U.S. coverage with a AA rating about a year ago, which was lowered to A+ last November. Dagong apparently views the United States as a greater risk than China. Despite all of America’s problems, that seems a stretch.

Update: In addition, Egan-Jones, a U.S. rating agency, cut the U.S. to AA+ in mid-July. Egan-Jones thus wins the prize as first U.S.-based agency to downgrade. Writing in the Financial Times, Michael Mackenzie noted:

Egan-Jones was officially recognised in 2008 by the Securities and Exchange Commission and, unlike its larger rivals, generates revenue from institutional investors and not from issuers of debt. During the past decade it downgraded US carmakers and structured credit products before similar decisions by the big rating agencies.

Thanks to reader Dan Diamond for pointing out the Egan-Jones downgrade.

11 thoughts on “Five Things You Should Know About the S&P Downgrade”

  1. And Number 6 – How This Will Take Money Out of Your Pocket

    Consumer and commercial interest rates will also increase because they hinge off of the t-bill rate. And increases in commercial credit costs will just be passed onto consumers.

    Think of this as the Great GOP Tax Hike of 2011 – except the extra money our of our pockets won’t go to help our country’s finances, it will go to China and Wall Street

    1. Oh, you must have gotten the DNC talking points memo. You forgot to call the Tea Party “terrorists” – as usual, when a liberal can’t win an argument with facts they resort to name calling.

      Inflation is already in the economy, and has been since 2 years ago when gas prices more than doubled, sending the cost of basic commodities like food and heat into the stratosphere.

      When I reach my credit limit and ask the bank to raise it, sometimes they agree. I can spend more, but again – it’s all on credit – and guess what, I pay the piper next time I want a loan because my credit score FALLS due to increased debt. It is precisely the same with the U.S., which is borrowing more than half of every dollar it spends – AND whose debt is now 100% equal to our GDP. None of this was caused by the GOP’s efforts to stop the spending, but don’t let the facts get in the way of your idealogical opinion!

      1. Leslie,
        The point of this article is that the US is seen to be losing it’s grip as a world leader. And in fact it has.

        As for you’r sneering commet at the start of your comment and the end, the GOP/tea party members have taught small-l liberals a lot about name calling. GOP/TP members just tell untruths.

      2. Leslie, you embody the exact political disfunction that S&P and pretty much the rest of the world sees. I am a Democrat and I would LOVE to lay the blame squarely on the GOP’s shoulders. I could in fact say that Bush spent us into massive debt by borrowing ridiculous amounts of cash from China to fight two unnecessary wars. But guess what, the Democrats were in control of Congress and could have fought a hell of a lot harder to tighten the budget and forced W to rethink his idea of a revenge war against Saddam. The roles were reversed in the 90’s when Clinton was in the white house and Newt and his fellow congressmen/women failed to control spending.

        My point is, instead of everyone pointing across the aisle looking to lay blame at the feet of those whose social beliefs don’t align with your own, we should look at the real problems facing this country and deal with those. Yes, we might disagree on equal rights for gays, gun rights, abortion, on and on, but I would be willing to bet that we would all agree that our debt is out of control and there are a lot of places that could use some trimmed fat, including entitlement programs AND defense spending. Let’s call a verbal cease fire and start working together before someone does in America what that psycho did in Norway.

      3. All spending originates in the House of Representatives. For the first six years of Bush’s term when the Republicans controlled Congress spending averaged about 200 billion per year. For the last two years of Bush’s term the Democrats were in control of both houses of Congress and spending was 1.9 trillion and 2.0 trillion for those two years. Then with the help of the biased media, the Democrats blamed all of the spending on Bush.

        More was spent on Obama, Pelosi, and Reid’s so called “stimulus” bill than was spent in eight years of the Iraq war.

        So before the Democrats took over, we got by just fine on 200 billion per year. Now every budget has the word trillion in it. Too much spending is the problem. It isn’t taxes. The Democrats refuse to make any real deals. They just wait out Republicans and the Republicans cave every time.

        Oh and Jason, you worry about an incident like the psycho happening here. What about the incident involving the psycho at Fort Hood? Or does that not count because the White House downplayed the significance of that terrorist attack?

  2. Has the rating change created any new class of securities that provide a feasible alternative?

  3. The danger is in the perception game here. However, on a much more simplified note, I think that as long as people are able to stay out of personal debt or personally master maintenance of their revenue streams, things will be okay. We should have just gone through all this ugliness years ago rather than dragging it out, but too many people were afraid to lose their careers.

  4. Dagong gives U. S. public debt the same rating as it does Estonia’s. Either China is extraordinarily sensitive about U. S. debt (likely), they know something that nobody else does (unlikely), or its ratings don’t have much relation to anything real.

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