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Sunday, August 7, 2011

S&P's downgrade of the United States

WASHINGTON – Standard & Poor’s announced Friday night it had downgraded the U.S. debt from AAA to AA-plus. Commentators split as to whether this will have major negative consequences for the U.S. and world economy, or whether it will be basically meaningless. Here’s the case for each position.

Because the U.S. debt was downgraded, many other debt instruments will likely get downgraded as well.

When Moody’s put U.S. debt on review for downgrade during the debt ceiling standoff, it also put on notice 7,000 other bonds, worth a total of $130 billion, that rely directly on revenue from federal government payments, such as certain kinds of municipal bonds. Bonds that are indirectly dependent on the federal government, such as those issued by hospitals that receive Medicare payments, or defense firms reliant on Pentagon contracts, could get downgraded as well.

In addition, many everyday interest rates – such as those for mortgages, car loans and credit cards – are pegged to U.S. Treasurys, meaning that if a downgrade forces up interest rates on U.S. debt (which is likely, but will depend on how the markets react), interest rates for those will shoot up as well.

It would also lead to widespread uncertainty. As the Washington Post’s Ezra Klein wrote when the debt-ceiling standoff threatened to force a downgrade, “The cornerstone of the global financial economy is the idea that Treasurys are risk-free.” A downgrade would mean Treasurys are no longer risk-free, and thus shake up the whole system. The last time AAA debt lost its luster in such a dramatic fashion was 2008, when AAA-rated subprime securities were discovered not to be sound. The result was the current crisis.

No. At AA+, the U.S. is still considered to have a "strong" ability to meet its obligations. In fact, only a handful of countries now have the AAA rating -- among them Canada, Germany, France and the United Kingdom. In addition, Treasuries have rallied this week, driving the yield on the benchmark 10-year note to 2.34 percent, its lowest level in about 10 months. This suggests people still view the U.S. as a safe place to invest.

Yes, but the savings from this are projected at $2.1 trillion. S&P has said that a larger level of savings is needed -- at least $4 trillion either through spending reductions or tax increases - are needed in order to start lowering U.S. deficits in coming years.

short-term credit rating of the U.S. is A-1+, the highest short-term rating. Money market funds with short-term debt are unlikely to be affected.

This is possible. Some large investors, such as William Gross of PIMCO, have said other markets such as Canada offer more value. But the U.S. market retains significant appeal because its bond market was more than $35 trillion at the end of March 2011, according to SIFMA. No other bond market is close to that size.

No. To begin with Standard & Poor's has assigned a "negative" outlook to the US long-term credit rating. That means another downgrade was possible in the next 12 to 18 months if it does not see an improvement in debt reduction. The other ratings agencies, Moody's and Fitch, currently still have a AAA rating on U.S. debt, which they just affirmed. But both of those agencies have suggested the U.S. could also be downgraded if projected government deficits are not reined in. Moody's currently has U.S. debt on review for possible downgrade.

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