US Sovereign Credit Rating Downgrade

by Nori Naka and Andrew Kwon

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. .

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[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.

The US Debt Ceiling Fiasco

by Jack Driscoll and Javi Halffter

The debt ceiling is the legal limit on borrowing by the federal government.[1] Since the 1980s, the debt ceiling has been raised from $985 billion dollars to a staggering $14.294 trillion.[2] After the 2008 financial crisis, the United States government took a great deal of responsibility to help the U.S. economy recover. Through various bank bailouts, stimulus programs, Federal Reserve rescue packages, and other financial initiatives, the United States Government committed over 11 trillion dollars, and has invested 3 trillion.[3] This action, along with the accumulated debt from previous budget deficits, has left the United States with a staggering 99% debt-to-GDP ratio. Raising the debt-ceiling is one of the least enjoyable things that Congress does, but it has been done without much trouble plenty of times in the past. However, in this case, both parties saw this time as an opportunity to gain votes for the upcoming elections. Problems began within the government last April when the tea-party faction of the Republican Party demanded at least $2 trillion in spending cuts, if the debt ceiling were to be raised. A couple weeks later, the US Treasury announced that the debt-ceiling had been reached and that if the problem wasn’t solved by August 2^, the country would default. Quickly, the issue evolved from finding ways to cut spending into a heated debate between partisan factions and their own ideologies. Republicans asked for major government spending cuts before agreeing to raise the ceiling, but they refused to increase taxes whatsoever. Meanwhile, Obama’s solution involved both increasing taxes and reducing government spending. Partisan politics and uncertainty harmed the reputation of the United States and the world economy as the deadline drew closer everyday. Negotiations persisted through August 1^st, but eventually the two parties came to terms and an agreement was reached to raise the debt ceiling by $2.4 trillion[4].

The deal approved by Congress was a short-term deal that only prevented the United States from defaulting. As a result of the political uncertainty and the unbalanced budget that the government still had after the plan was passed, Wall Street suffered its worst losses since 2008. The Dow Jones industrial Average dropped 2100 points, 16%, from its year high and the United States long-term credit rating was downgraded for the first time in the history of the country. We believe that unilateralism in Washington by both the Republicans and Democrats harmed the economy more and that the debt-ceiling plan was a fiasco. The stubbornness of both parties to implement the policies they believe in put the economy at great risk, and the United States cannot afford to have this problem again. In order to solve this current economic crisis and save the economy from dipping back into a recession, the White House needs to work together with the House of Representatives to find a long-term deal, which should include budget cuts and tax raises.

Sources:

Eunjung Cha, Ariana. "What's the debt ceiling, and why is everyone in Washington talking about it?." Washington Post (2011), http://www.washingtonpost.com/business/economy/whats-the-debt-ceiling-and-why-is-everyone-in-washington-talking-about-it/2011/04/15/AFSS4R1D_story.html (accessed October 17, 2011).

Federal Reserve, Treasury, FDIC, CBO, White House. "Follow the money: Bailout tracker." CNN. http://money.cnn.com/news/storysupplement/economy/bailouttracker/ (accessed October 11, 2011).

Carlson, Margaret. "Obama, Boehner Look Smaller After Their Big Debt Deal: Margaret Carlson." Bloomberg. http://www.bloomberg.com/news/2011-08-03/obama-boehner-look-smaller-after-their-big-debt-deal-margaret-carlson.html (accessed October 12, 2011).

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[1] Eunjung Cha, Ariana. "What's the debt ceiling, and why is everyone in Washington talking about it?." Washington Post (2011), http://www.washingtonpost.com/business/economy/whats-the-debt-ceiling-and-why-is-everyone-in-washington-talking-about-it/2011/04/15/AFSS4R1D_story.html (accessed October 17, 2011).

[2] ibid

[3] Federal Reserve, Treasury, FDIC, CBO, White House. "Follow the money: Bailout tracker." CNN. http://money.cnn.com/news/storysupplement/economy/bailouttracker/ (accessed October 11, 2011).

[4] Carlson, Margaret. "Obama, Boehner Look Smaller After Their Big Debt Deal: Margaret Carlson." Bloomberg. http://www.bloomberg.com/news/2011-08-03/obama-boehner-look-smaller-after-their-big-debt-deal-margaret-carlson.html (accessed October 12, 2011).