Downgrading the U.S. Credit Rating

On Friday, August 5th, after the close of the U.S. securities markets, Standard & Poor’s (S&P) reduced its rating of the U.S. Government’s debt from S&P’s highest rating of “AAA” to its second highest rating of “AA+.” [1]

S&P’s announcement of this action was headlined: “United States of America Long-Term Rating Lowered To ‘AA+’ Due To Political Risks, Rising Debt Burden; Outlook Negative.” The key reasons for this downgrade were the following:

  • “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.” [2]

In short, this objective outsider concluded, properly I think, that the U.S. “policymaking and political institutions” are not working. As S&P further stated, the U.S. recently has seen “political brinksmanship,” and “the statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy.” In addition, S&P noted that “new revenues have dropped down on the menu of policy options.”[3]

While these observations are appropriately phrased in terms of the “U.S. policymaking and political institutions,” they really are a negative assessment of the political objectives, strategy and tactics of the Tea Party contingent of the Republicans in the House of Representatives and to a lesser extent in the Senate.[4]

Moreover, according to S&P, “the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging.”[5] This comment raises the important need for the U.S. to reduce unemployment and achieve higher economic growth, which is made more difficult by the austerity measures promised in the debt ceiling compromise that became law on Tuesday, August 2nd.[6]

If the above were not enough criticism of the U.S. federal government, S&P made the following two ominous statements about its future actions:

  • First, S&P signaled that on Monday, August 8th, it will be downgrading its credit ratings of “the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors.”
  • Second, S&P said, “The outlook on the long-term rating [of the U.S.] 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.”[7] This warning stemmed from S&P’s “downward scenario.” There were two key facts for this scenario. The “recent [U.S.] recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher.” The U.S. is experiencing “sub-par path of the current economic recovery when compared with rebounds following previous post-war recessions.”[8]

Although two other independent credit-rating entities did not change their top ratings of the U.S. government, S&P’s downgrade, the rationale for its downgrade and its ominous warnings of further negative assessments of the U.S. undoubtedly will create next week another turbulent period in U.S. and world security markets.


[1] S&P, United States of America Long-Term Debt Rating Lowered to ‘AA+’ Due To Political Risks, Rising Debt Burden; Outlook Negative (Aug. 5, 2011), http://www.standardandpoors.com.

[2]  Id.

[3]  Id.

[4]  See Post: Disgusting U.S. Political Scene (July 23, 2011); Post: The Founder of Modern Conservatism’s Perspective on the Current U.S. Political Turmoil (July 28, 2011); Post: A Message for Speaker Boehner (July 29, 2011); Post: Dysfunctional U.S. Congress Careens Toward U.S. Default (July 30, 2011); Post: Dysfunctional U.S. Congress Averts Default (Aug. 2, 2011); Editorial, Political Roots in U.S. Economic Crisis, N.Y. Times (Aug. 5, 2011).

[5]  See n.1 supra.

[6]  See n.3 supra.

[7]  See n.1 supra.

[8]  Id.

 

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dwkcommentaries

As a retired lawyer and adjunct law professor, Duane W. Krohnke has developed strong interests in U.S. and international law, politics and history. He also is a Christian and an active member of Minneapolis’ Westminster Presbyterian Church. His blog draws from these and other interests. He delights in the writing freedom of blogging that does not follow a preordained logical structure. The ex post facto logical organization of the posts and comments is set forth in the continually being revised “List of Posts and Comments–Topical” in the Pages section on the right side of the blog.

2 thoughts on “Downgrading the U.S. Credit Rating”

  1. dwkcommentaries (Aug. 7, 2011).

    On Saturday, August 6, the White House criticized S&P’s downgrade of U.S. debt as unjustified by being based on faulty math, but S&P defended its decision. It said that it was entirely appropriate for S&P to focus on U.S. political problems as the “debacle over the debt ceiling continued until almost the midnight hour.” Others in Washington also criticized the downgrade. (Schwartz & Dash, Amid Criticism on Downgrade of U.S., S&P Fires Back, N.Y. Times (Aug. 6, 2011); Story, Creswell & Morgenson, Anger Over Credit Rating Resurfaces in Washington, N.Y. Times (Aug. 6, 2011).)

    China, the largest foreign holder of U.S. debt, said that Washington needed to “cure its addiction to debts” and “live within its means.” Leaders in Europe and elsewhere expressed their worries about the downgrade while trying to prevent loss of confidence in U.S. economy.(Barboza, China Tells U.S. It Must ‘Cure Its Addiction to Debt’, N.Y. Times (Aug. 6, 2011); Alderman, Some Concern Abroad About U.S. Debt Downgrade, N.Y. Times (Aug. 6, 2011); Helm, Pratley & Branigan, Global leaders race to stem panic over US credit rating downgrade, Observer (Aug. 6, 2011).)

    Meanwhile, it has been reported that in January 2011, then newly installed GOP House majority leader, Eric Cantor, told the Republican Representatives that the then approaching vote to increase the debt limit was a “hidden opportunity” and a “leverage moment” to achieve their goal of shrinking the federal government and its spending. (MacGillis & Montgomery, Origins of the debt showdown, Wash. Post (Aug. 6, 2011).)

  2. Additional Credit Ratings Downgrades by S&P

    On Monday morning, August 8th, Standard & Poor’s lowered its credit ratings from “AAA” to “AA+” for various entities related to the U.S. federal government (Fannie Mae, Freddie Mac, 10 Federal Home Loan Banks, certain senior debt (FHLB System and Federal Farm Credit Banks). This was due to their direct or indirect reliance on the U.S. government. (Latest Updates on the Market Upheaval, N.Y. times (Aug. 8, 2011).

    This was anticipated as S&P on Friday, August 5th, signaled that on Monday it would be downgrading its credit ratings of “the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors” of the U.S. (Post: Downgrading the U.S. Credit Rating (Aug. 6, 2011).)

    On Monday morning the U.S. stock markets were down. (Hauser & Jolly, Stocks Slump in First U.S. Trading Since Downgrade, N.Y. Times (Aug. 8, 2011).)

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