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:
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.