Wednesday, April 20, 2011

Standard & Poor’s Signals a Possible Downgrade of U.S. Sovereign Debt Ratings

LA Times: Surprise Warning on U.S. Debt Comes as Washington Inches Away from Gridlock
WSJ: U.S. Warned on Debt Load
NYT: Moody’s Says U.S. Debt Could Test Triple-A Rating
CBS: S&P Lowers U.S. Debt Rating to "Negative"

This past Monday, Standard & Poor’s, a leading credit rating firm, changed its long-term outlook regarding U.S. Treasury securities from “stable” to “negative.” The firm revised its outlook after concluding that there was a 33-percent chance that it would have to lower the rating of U.S. government debt in the next two years. While, for the time being, Standard & Poor’s affirmed its AAA rating of U.S. Treasurys, the firm warned that the country’s rising deficit posed a severe threat to U.S. government debt ratings. Standard & Poor’s opined that if the government failed to immediately address its ballooning budget deficit, by 2013 U.S. finances would be “meaningfully weaker” than those of other AAA-rated countries, thus necessitating a credit rating reduction.

A credit rating is an indication of the likelihood that a debtor will pay back a loan. A credit-rating reduction for U.S. Treasurys will impact not only national pride. The government will no longer be able to keep borrowing money on extremely favorable terms because investors will demand higher interest rates due to the Treasurys’ lower credit rating. Higher interest rates will, in turn, increase the government’s overall debt burden, and may lead to higher taxes, spending cuts, or some combination of both. Additionally, such a downgrade will probably drive U.S. interest rates higher, which will negatively affect consumer spending and jeopardize the country’s economic recovery.

Standard & Poor’s started assigning outlooks for government debt in 1989. Since then, five AAA-rated countries have received a negative outlook, and only two of them managed to avoid a subsequent credit rating downgrade. Great Britain provides the most recent example of how to accomplish that. In 2009, the country’s deficit reached 11.2 percent of its gross domestic product (“GDP”), and Standard & Poor’s assigned a negative outlook for British sovereign debt. To reduce its deficit, the British government cut spending and raised revenues. Standard & Poor’s evaluated the government’s austerity measures and concluded that they would reduce the deficit to 3 percent of GDP by 2014. As a result, the firm restored its stable outlook for British government debt.

If the U.S. government is to prevent a credit-rating downgrade, it must simply follow Great Britain’s example. Experts are unanimous that although economic growth may help reduce the growing U.S. deficit, it will not alone be sufficient. Cutting spending and raising taxes is the only proven path to reducing government deficit. Only time will show whether U.S. politicians will muster up the political will to pass such painful and unpopular, but necessary, austerity measures.


Bill@ etf trend trading review said...

Hi, great post. And it is really troubling news for the US economy. Even if the rating is not in effect yet, it is making big news.

Hristo Chaprazov said...

Agreed. What I am anxious to see is whether U.S. politicians will manage to put aside their differences and agree on some form of deficit reduction.