S&P downgrades U.S. credit rating

Standard & Poor’s lowered the U.S. credit rating late Friday (Aug. 5) saying the recent budget-debt ceiling deal passed by Congress doesn’t do enough to stabilize the federal government’s financial position.

The S&P lowered the U.S. sovereign credit rating to AA+ from AAA. The U.S. has held the top AAA rating for more than 70 years.

Not only did the S&P issue a downgrade, but the report included a warning of future downgrades.

“The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case,” S&P noted in the report.

Economists, politicians and pundits immediately debated the extent to which the reduced rating will have an impact on the U.S. economy.

As a practical matter, the lowered rating is likely to increase borrowing costs for the federal government and state and local governments. It is also likely to raise interest rates for home loans, credit cards and personal and business loans.

Some analysts suggest the effect will be more psychological than practical, while others argue that the downgrade could create a political backlash that forces members of Congress and President Obama to take significant debt reduction actions. Such actions, according to the S&P, could include deep spending cuts and tax increases. Link to this report from Reuters to read opinions from financial industry experts.

Mohamed El-Erian, chief executive of bond fund PIMCO, says Congress must treat this as a financial "Sputnik moment,” according to this story from the Christian Science Monitor.

"For the sake of their country and the wider global economy, both parties should resist the urge to begin bickering," El-Erian wrote in an opinion piece for the Financial Times. "Instead they should seize this potential ‘Sputnik Moment’ – a visible shock to the national psyche that can unify Americans around a common vision and a renewed sense of purpose."

Following are excerpts from the S&P ratings downgrade.
• 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.

• 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.

• Under our revised base case fiscal scenario — which we consider to be consistent with a ‘AA+’ long-term rating and a negative outlook — we now project that net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021.