Thoughts on a Possible US Credit Downgrade

by Michael on Oct 16, 2013 · 5 comments

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Remember what happened last time we bumped up against the debt ceiling and it looked like we might willingly default? That’s right, a major rating agency downgraded our credit rating.

Indeed, back in August 2011, Standard & Poor’s dropped our rating from Aaa to Aa+. In doing so, they laid the blame squarely at the feet of dysfunction in DC, saying:

“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.”

At the same time, Moody’s and Fitch both upheld our Aaa rating, thought it appears that might be changing. In fact, Fitch just placed the US credit rating on “negative watch,” meaning that they’re considering a possible downgrade.

Why credit ratings matter

Okay, so why does this really matter? Are there any real consequences to a credit downgrade? Or are we just talking about bragging rights? I mean, won’t the US Treasury be just as safe next week as it was last week?

Well… US Treasury securities are generally viewed as being risk-free, in that they’re backed by the “full faith and credit” of the US government. This risk-free reputation means that the government can borrow at relatively low rates.

If it becomes clear that Congress is willing to play chicken with its debt obligations on an ongoing basis, that perception may begin to change. When that happens, it’s entirely possible that investors will start demanding higher rates to compensate them for the higher risk associated with Treasuries.

And higher rates will, of course, have a negative impact on a number of things.

For starters, even more of our Federal budget will go toward the servicing of our national debt. Rising rates will also devalue existing bonds causing losses in the bond market — though newer issues will offer higher yields.

A credit downgrade could also translate into things like higher mortgage rates, which would put negative pressure on a recovering real estate market. And other consumer lending products could likewise see higher rates going forward.

In other words, yes, there could be very real consequences associated with another downgrade. That being said, the first downgrade didn’t seem to have too much of an impact, perhaps because there aren’t many better options out there.

Countries with sterling credit

Speaking of alternatives, I thought it would be interesting to take a look at which countries still have Aaa ratings across all three major ratings agencies.

Here’s the list:

  • Australia
  • Canada
  • Denmark
  • Finland
  • Germany
  • Luxembourg
  • Netherlands
  • Norway
  • Singapore
  • Sweden
  • Swizerland

So… There you have it. Until the summer of 2011 we were on that list. And now it looks like we may be moving even further away from it.

Hopefully things will get sorted out this week and we’ll be left to worry about superficial issues like credit ratings vs. the possibility of an actual default.

1 Little House October 17, 2013 at 9:49 am

Based on the agreement that was struck, looks like we’ve delayed any real action for another three months.

2 thepotatohead October 17, 2013 at 11:39 pm

Kicking the can down the road yet again, who is providing the popcorn for the next circus in a few months?

3 Edward Antrobus October 18, 2013 at 10:51 am

Ratings agencies seem to be a whole lot more concerned than the average investor. NPR did a piece this morning where they bought a T-bill at the beginning of the week. Right as the debt ceiling limit debate was in its highest gear, it was selling at a discount of only 26 cents. That’s less than a tenth of a percent. And now, the price is up to just a penny discount. That seems to dictate that an awful lot of people just aren’t concerned that it would actually happen.

4 SuburbanFinance October 21, 2013 at 9:07 am

I am surprised that Canada has a triple A rating, because we have definitely run into some financial conundrums over here in the great white North. But I’m not surprised about Switzerland.

5 Evan October 25, 2013 at 12:49 am

We dodged the problem for now…but I am not sure why the credit agencies have any clout after the 2008 real estate crises. They completely dropped the ball! Wasn’t Lehman AAa until the night before they declared bankruptcy? lol

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