On Friday, August 5th, 2011, Standard and Poor (S&P), one of the most reliable credit rating agencies, downgraded the US long-term sovereign credit rating from AAA to AA+. This has not happened in 70 years and shakes off the facade that US Treasury debt is stable.[1] AAA ratings are assigned to the debts of companies and governments that are considered the safest investments. This downgrade in credit rating suggests to investors that countries such as Australia, Canada, and Denmark are safer options than the US in terms of investing their finances. This decision was made because of Congress and the Administration’s inability to follow through with an effective and efficient fiscal consolidation plan, which S&P believes is necessary for the US’s debt stability.[2] S&P predicts further decline of the US credit rating due to political instability and irresponsibility. For many of the government officials in the US, this was a wake up call: no longer will there be excessive spending without compromising trust that people have in the US debt rating.
Theoretically, nominal interest rates would have increased with bond prices decreasing because of a decrease in demand for US Treasury bonds. However, the opposite occurred because investors still believed in the safety of US securities. Many believed that if US securities were being downgraded, that the global economic situation must be dismal overall and that other investments would be even more unstable and risky.
This historic and significant downgrade in the US debt rating made a damaging impact on the US economy, as Standard and Poor’s essentially declared that the US Treasury is no longer one of the safest investments in the world. Though there was an initial $2 trillion error in S&P’s debt calculations, it has been clear that US debt is an unavoidable issue[3]. The downgrade was not a major surprise as S&P had hinted at it for some time, and it was simply a credible analysis of where the US economy is headed. That being said, analysts stated the ramifications of the downgrade could cause unwanted and unnecessary problems for the US economy, as psychological effects on investors can arise and investment from foreigners will be less appealing. With the US economy already in trouble, one can argue that S&P’s downgrade occurred at the worst timing, especially considering the fact that other credit rating agencies like Moody’s and Fitch kept up their ratings for the US. However, it can also be perceived as a positive red flag for policymakers. But as the opposite of analysts’ predictions has happened, the only way to determine whether the downgrade was necessary is to look at its long-term results. Anthony Valeri, a market strategist for LPL Financial in San Diego, said, “It’s a reflection of the fact that we haven’t done enough to get our fiscal house in order.”[4]
John Detrixhe, “U.S. Loses AAA Credit Rating as S&P Slams Debt Levels, Political Process - Bloomberg,” Bloomberg, August 6, 2011, http://www.bloomberg.com/news/2011-08-06/u-s-credit-rating-cut-by-s-p-for-first-time-on-deficit-reduction-accord.html.
Paletta, Damian, and Matt Phillips. "S&P Downgrades U.S. Debt for First Time - WSJ.com." Business News & Financial News - The Wall Street Journal - Wsj.com. Wall Street Journal, 06 Aug. 2011. Web. 12 Oct. 2011.
"S&P | United States of America Long-Term Rating Lowered To 'AA ' Due To Political Risks, Rising Debt Burden; Outlook Negative | Americas." United States of America Long-Term Rating Lowered To 'AA+' Due To Political Risks, Rising Debt Burden; Outlook Negative. Standard and Poor's, 05 Aug. 2011. Web. 12 Oct. 2011.
"S&P's Credit Rating Cut: Downgrading Our Politics | The Economist." The Economist - World News, Politics, Economics, Business & Finance. The Economist, 06 Aug. 2011. Web. 12 Oct. 2011.
"The Debt Ceiling Crisis: US Credit Rating Downgraded | The Economist." The Economist - World News, Politics, Economics, Business & Finance. The Economist, 03 Aug. 2011. Web. 12 Oct. 2011.
[1] Paletta, Damian, and Matt Phillips. "S&P Downgrades U.S. Debt for First Time - WSJ.com." Business News & Financial News - The Wall Street Journal - Wsj.com. Wall Street Journal, 06 Aug. 2011. Web. 12 Oct. 2011.
[2] "S&P | United States of America Long-Term Rating Lowered To 'AA ' Due To Political Risks, Rising Debt Burden; Outlook Negative | Americas." United States of America Long-Term Rating Lowered To 'AA+' Due To Political Risks, Rising Debt Burden; Outlook Negative. Standard and Poor's, 05 Aug. 2011. Web. 12 Oct. 2011.
[3] Damian Paletta and Matt Phillips, “S&P Downgrades U.S. Debt for First Time - WSJ.com,” Wall Street Journal Online, August 6, 2011, http://online.wsj.com/article/SB10001424053111903366504576490841235575386.html.
[4] John Detrixhe, “U.S. Loses AAA Credit Rating as S&P Slams Debt Levels, Political Process - Bloomberg,” Bloomberg, August 6, 2011, http://www.bloomberg.com/news/2011-08-06/u-s-credit-rating-cut-by-s-p-for-first-time-on-deficit-reduction-accord.html.
2 comments:
i really like this article. i felt like you guys did a strong job as you had detailed description. however, i, as the reader and potential investor, would like to know more about the forecasted effects of the downgrade on the U.S. economy. also, i would have liked to have known what the credit downgrade means in terms of foreign investor confidence in the u.s.
Thanks Rafiq! At first glance one would think that the credit downgrade would heavily decrease the demand for U.S. Treasury bonds because of the mounting risk. However, in reality, since the U.S. Treasury bonds are considered to be the safest in the world, it made people more worried about their investments everywhere else. So, the downgrade had quite a different outcome than what one would have predicted, and there was not a downward spiral in terms of foreign investment to the United States. Good question!
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