Congress’ inability to find a substantive solution to our nation’s debt crisis resulted in Standard & Poor’s (S&P) downgrading the U.S. long-term debt from AAA to AA+, on August 5, sending shock waves throughout the global financial markets.
Fundamentally, the downgrade represents a loss of faith in America’s ability to pay off its debts, and will have a negative affect on America’s economy as a whole moving forward.
A lower credit rating may lead to higher interest rates on U.S. Treasury bonds which means higher credit card and mortgage payments for average Americans. That said, in the short-term investors continue to buy treasuries as U.S. bonds still provide a safer alternative to the uncertainty of the stock market.
What led to the downgrade?
S&P’s downgrade demonstrates the economic ramifications of the political gridlock in Washington. Congress reached an eleventh hour deal to raise the debt ceiling, barely saving our nation from default. However, S&P responded stating the compromise, “falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” S&P further cited a “lack of apparent willingness of elected officials as a group to deal with the U.S. medium term fiscal outlook” as a justification for downgrade.
What are credit ratings?
There are three national credit rating agencies that assess the creditworthiness of governments, companies, and individual securities: Fitch, Moody’s Investor Service, and Standard & Poor’s. These agencies determine the level of risk for a wide-range of investments -- the safer the investment, the higher the rating. And safer investments mean lower interest rates associated with borrowing funds.
What does downgrade mean for you?
Rising interest rates
A credit rating downgrade reflects uncertainty in the U.S government’s ability to pay back its debt over time. This loss of confidence means it is now riskier to invest in U.S. Treasury bonds, according to S&P.
Therefore, in order for the nation to borrow funds, the Treasury may have to pay higher interest rates to compensate investors for the additional risk they are taking. As a result, the U.S. government could face spending billions more on interest payments that will further increase our national debt. In addition, because many consumer loans, such as mortgages, are linked to the yield on Treasury bonds it may cost more for you to borrow money for a new house or car. Simply put, if the U.S. government pays more, you pay more.
State and local impact
Effects of the downgrade may even trickle down to the state level. Individual states could experience their own credit rating downgrade resulting in higher interest payments, which could lead to state tax increases or spending cuts. The states would be forced to choose whether to cut programs such as education, health care, or law enforcement or increase revenues through tax hikes.
Although S&P notes that U.S. state and local governments enjoy considerable financial autonomy from Uncle Sam, according to The Hill, as of August 9 only 13 states have maintained their AAA rating: Delaware, Florida, Georgia, Indiana, Iowa, Maryland, Minnesota, Missouri, Nebraska, North Carolina, Utah, Virginia, Wyoming.