You’ve probably heard the news already—our country’s credit rating just took a dive.
On Friday evening, Standard & Poor’s, one of the world's three major credit rating agencies, dealt a major blow to the United States’ financial psyche by announcing that it has downgraded the country’s credit rating from AAA to AA+. This marks the first time in history that the U.S. has lost its top-ranked credit rating from one of the major agencies.
The U.S. moves from the company of other AAA countries like Australia, Canada, France, Singapore and Germany to the company of the two AA+ countries, Belgium and New Zealand. The world is reeling with varied reactions to this news, as analysts try to predict what this will mean for the domestic and global economies. Is this media hype or true disaster? Can we fix the situation and earn our AAA score back? And what does this mean for the average American?
We cut through the noise to bring you the cheat sheet on the credit rating downgrade, the various viewpoints on the downgrade itself, its potential effects—and what it means for you.
What Happened—In a Snapshot
As we reported in our story last week summarizing the debt ceiling deal, governments receive credit rating scores that investors use to analyze credit-worthiness. These credit scores are determined by three major international credit reporting agencies: Moody's, Fitch and Standard & Poor's.
After the debt ceiling deal was struck, Moody's and Fitch maintained their AAA scores for the U.S. (although Moody's downgraded the U.S. credit outlook to "negative"). S&P, on the other hand, decided on Friday to downgrade the U.S.'s credit rating to AA+. For the first time in history, America lost its unanimous AAA rating across all three agencies. On a side note, however, China's leading credit agency Dagong Global Credit Rating Co. stripped America, Britain, Germany and France of their AAA ratings last July, accusing the top three agencies of Western bias, and giving greater weight to "wealth creating capacity."
Two Key Points About the Downgrade:
- At first, S&P made a numerical error in a draft report, overstating the deficit by $2 trillion. When the error was brought to its attention, S&P stuck to its decision to downgrade the U.S. credit rating.
- S&P cited politics as a key reason for the downgrade: A representative stated that the government's "political brinkmanship" in the debt debate made its ability to manage its finances "less stable, less effective and less predictable."
Critics of the Downgrade:
U.S. Treasury reps and Obama administration officials call this decision "hasty" and "amateur," based on the huge accounting error. "A judgment flawed by a $2 trillion error speaks for itself," a Treasury spokesman said Friday night. Additionally, some critics call this downgrade "hypocritical," since S&P largely contributed to the real estate crash and the recession, greatly overvaluing real estate assets—but now holds the U.S. government responsible for the fallout. Others point out that S&P wields tremendous power but isn't accountable for its actions, since its officials aren't elected.
Proponents of the Downgrade:
S&P says it has been issuing warnings for months now—it put the U.S. credit rating on negative watch back in April. Accounting error aside, S&P holds that the government's new plan didn't include $4 trillion in cuts, which the agency deems necessary to reduce the country's debt over the next decade. As for the politics, S&P emphasizes its lack of confidence in our bipartisan government's ability to get past bickering to construct a successful plan to get us out of the debt mess, and many pundits agree. It's like determining credit-worthiness for a couple, rather than an individual—and one that fights constantly and can't agree on a plan.
Regardless of the validity of this rating, most agree that our budget needs fixing. And since the budget is about both numbers and process, the parties need to stop the infighting and come together to craft a solid path toward economic recovery.
What This Means for the U.S. and Global Economies
The U.S.'s AAA rating has made the U.S. Treasury bond one of the world's safest investments, and has allowed the U.S. to borrow at extraordinarily low interest rates to finance our government operations—what will happen now?
We'll Be Fine:
Some believe the downgrade is more of a symbolic than an economic event, and the market response will be muted, due to the U.S.'s relative standing in the world. While the U.S. market opened low today, and international markets have taken some dips, not everyone is flocking to sell their U.S. Treasury bonds--in contrast to dire predictions from some analysts. David Beers, the S&P global head of sovereign ratings, told Fox News that he didn't expect interest rates to spike. Others are quick to remind that countries such as Japan, Canada and Australia have shrugged off downgrades with minimal effect, and five countries (Australia, Canada, Denmark, Finland and Sweden) have regained their AAA status after losing it—certainly a possibility for the U.S. (though it may be a while--history shows it takes from nine to 18 years). Among other countries that are confident in the United States' financial future? Australia and France, who point out that the U.S. economy is still "one of the most powerful in the world."
We Won't Be Fine:
This morning, the Dow posted its biggest weekly point loss since the financial crisis in 2008, falling 5.8%. Some analysts say that interest rates will certainly rise, which will increase borrowing costs for the U.S. government, costing taxpayers tens of billions of dollars a year. Interest rates would rise for consumers and companies seeking mortgages, credit cards and loans—so everyone would feel this hit. And many other types of bonds are linked to the national credit rating: municipalities, states, hospital bonds. Additionally, some speculate that if progress isn't made by Congress, Moody's may also lower its U.S. credit rating to AA in the next six months to a year, further validating the country's credit downgrade. More importantly, the U.S.'s reputation as a world economic superpower has been tarnished, the consequences of which could be long term and far-reaching. China, the U.S.'s largest single creditor, has been especially critical of the U.S. in reacting to the downgrade, its officials stating: "To cure its addiction to debts, the United States has to re-establish the common sense principle that one should live within its means." Ouch.
Although there will be immediate reverberations, we probably won't really know the full effects of the downgrade for months.
What This Means for You
- First and foremost, don't panic. Don't do anything rash like dump your stocks or bonds.
- Hang on tight to your investments—remember, we always recommend investing for the long haul (or doing as Warren Buffett does, which is investing like a girl). Markets usually stabilize themselves over the long term.
- Be a voice: Write or call your representatives to express your point of view, whether to cut or save programs. If you want to protect certain programs, make your views known, as everything will be on the chopping block over the next few months as Congress tackles the budget plan.
- Buckle down to save for emergencies and retirement, because it's possible that Social Security and other safety net programs will get restructured or cut.
Hold steady, and invest aggressively in your long term safety net.
Now more than ever, LearnVest is here to help you master your finances—check out our new My Money Center for a fun and efficient way to handle your budget and grow your net worth. As I mentioned in a BBC World Have Your Say segment last week on debt defaulting, a nation's path is made up of individual decisions. At LearnVest we feel it's as important to change a culture—a people's way of thinking about spending and debt—as it is to form the right policy. So get started with yourself.