S&P Goes Through With It; Downgrades U.S. Debt

By David Moenning

August 5, 2011

In a press release Friday evening, Standard & Poor�s downgraded the U.S. Government�s �AAA� sovereign debt rating Friday evening. S&P lowered the long-term rating to AA+ from AAA and affirmed the country�s A-1+ short-term rating.

The rating agency said �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 Press release goes on to say, �More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011. Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government�s debt dynamics any time soon.�

S&P says that the outlook on the long-term rating remains negative and that the rating could be cut to AA within the next two years if they do not see the reduction in spending that Congress and the White House agreed to. In addition, higher interest rates or new fiscal pressures in the future that results in higher gov�t debt likely trigger an additional downgrade.

This is the first time in the country�s history that the U.S. has lost its top-notch credit rating. S&P has maintained the U.S. at AAA for 70 years.

CNBC reports that U.S. Treasury securities, which up until now have been seen as the safest investment in the world, are now rated lower than bonds issued by countries such as the UK, Germany, France or Canada.

The downgrade came amid swirling controversy over the math involved with calculating the debt-to-GDP ratio in the U.S. According to Dow Jones, the White House had directly challenged the analysis made by S&P and said the credit rater was �trillions� off in its calculations.

CNBC reports that the error was purported to be in the calculation of the U.S. debt-to-GDP ratio over time and was based on a misreading of the correct congressional baseline numbers.

The rumors of the S&P downgrade were part of the massive volatility seen in the stock market on Friday, where the DJIA traded in a 416 point range.

Recall that both Fitch and Moody�s had confirmed their triple-A rating for U.S. debt this week. Although Fitch said that the U.S. rating would likely remain under pressure for some time.

Moody�s kept the rating at triple-A, but slapped a �negative outlook� on U.S. debt. Moody's said there would be a risk of a downgrade if (a) There is a weakening in fiscal discipline in the coming year; (b) If further fiscal consolidation measures are not adopted in 2013; (c) If the economic outlook deteriorates significantly; or (d) There is an appreciable rise in the US government's funding costs over and above what is currently expected."

However, S&P had painted itself into the downgrade corner by publically saying that the U.S. needed to make cuts of at least $4 trillion from the budget over the next 10 years to avoid default. And with the debt-ceiling deal calling for cuts of just $2.4 trillion, S&P apparently had to maintain its credibility with the downgrade.

It is likely that S&P waited until after markets had closed Friday to make their announcement so that traders (and their computers) wouldn�t overreact and create even more chaos than was already present.

History shows that an initial downgrade to a country�s sovereign debt rating isn�t the end of the world as rates often fall after the announcement is made. And given that the U.S. may be the �only game in town� for borrowers such as China, many experts are not overly concerned about the impact of the downgrade on interest rates.

However, the move may prove to be problematic to the U.S. consumer, who, according to the