By now, I’m sure you’ve heard that Standard & Poor’s rating agency downgraded the US credit rating from Aaa to Aa+. While the other two ratings agencies (Moody’s and Fitch) have upheld the Aaa rating – at least for now – S&P’s decision to downgrade has sent shockwaves across the investing world.
While I don’t want this to devolve into a political argument, I do think it’s worth noting that S&P partly based their downgrade on the political dysfunction surrounding the debt ceiling debate in Washington. More specifically:
“The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.”
Who cares about credit ratings?
Okay, aside from bragging rights, who really cares? After all, the US Treasury is just as safe (or unsafe) today as it was on Friday before the downgrade. Right? While that may be technically true, it’s all about perception.
The problem is that, if people start to lose faith in the “risk-free” nature of Treasury securities, borrowing prices will rise. In other words, investors could begin demanding higher interest rates to compensate them for the higher risk (real or perceived) associated with Treasuries.
Okay, got it. Higher rates. But who really cares about that? All of us should. Higher borrowing costs means that more of our Federal budget will have to be devoted debt service, and we’ll have to cut even deeper (and/or revisit the revenue [tax] issue) in order to get the deficit under control.
As for investors, rising interest rates will devalue existing bonds, causing losses in the bond market – though resulting in higher yields, and thus higher income per dollar invested. Also, the downgrade could create problems for money funds that are required to hold Aaa-grade investments.
Note: In the short term, Treasuries might actually benefit, as spooked investors flee the stock market in search of safer investments – in fact, that’s exactly what happened overnight, as bond buying on the international markets pushed rates lower (and prices higher).
And finally, for consumers… The downgrade could translate into higher mortgage rates, putting further pressure on an already weak real estate market. The same goes for interest rates on car loans, credit cards, etc. So yes, you probably should care about this, though it’s still unclear exactly how much of an impact the downgrade will have.
Which countries still have Aaa credit?
Now that the downgrade has occurred, you might be wondering who does have a Aaa credit rating. According to S&P, these are the 18 countries that still have sterling credit:
- Hong Kong
- Isle of Man
- United Kingdom
If you’re interested in seeing the full list, as well as the Moody’s and Fitch ratings, check Wikipedia’s list of countries by credit ratings.
Are credit ratings reliable?
As an interesting aside, there are now four US companies that have higher credit ratings than the Federal government: Microsoft (MSFT), Exxon Mobil (XOM), Johnson & Johnson (JNJ), and Automatic Data Processing (ADP). Then Enron, Global Crossing, Bear Sterns, and others also had Aaa ratings right up to the bitter end.
Thus, you might want to view this whole ratings game with a healthy dose of skepticism. After all, ratings changes often appear to be reactionary – being based on things that have already happened – as opposed to offering a forward-looking perspective.
In the case of the US credit downgrade, it was no secret that a downgrade was looming. Thus, while the occurrence of the downgrade itself was unsettling, investors have had plenty of time to digest the likelihood that it would happen, and it should already be at least partially “priced into” the market.
This isn’t to say that the stock market won’t swoon – it probably will, at least a bit – but we’ve known for awhile now that the debt ceiling deal didn’t add up to the $4T in deficit reductions that S&P was looking for, and we already saw a lot of selling in the wake of that deal.
Note: I will wield a heavy hand on political rants, name-calling, etc. in the comments. Thus, while I encourage you to discuss the economic implications of the downgrade, I’m asking that you keep your comments respectful and on-topic, and that you steer clear of political discussion.