S&P Lowers U.S. Debt Rating For the First Time in Seventy Years

Arjun Dave
06 Aug, 2011
New York City

Standard & Poor

[R]9:30 AM New York – Standard & Poor’s lowered its rating by one notch for the U.S. long term debt with a negative outlook. The U.S. was removed from its highest rating for the first time after seventy years and the rating agency blamed on the lack of new revenues and not sufficient spending cuts in the next ten years.[/R]

Standard & Poor’s lowered its credit rating for the long-term U.S. government debt to AA+ from AAA with a “negative outlook.” The rating agency left its view on the short term debt unchanged.

The first downgrade of the U.S. debt in seventy years since 1941 may be lowered further in the next two years if Congress fails to end Bush-era tax cuts or lower spending.

The other two rating agencies Moody’s Investors Service and Fitch Ratings have not changed their outlook on the U.S. government debt and affirmed their highest rating on August 2.

If Moody’s and Fitch do not lower their outlook in the next two weeks, the latest action by the S&P will have little impact on financial markets this week.

The New York based rating agency has been vocal about the U.S. government debt for the last three months and the last month said that its highest rating for the U.S. debt may be in jeopardy.

The latest downgrade is no surprise to most investors around the world as there is no new information that the rating agency has shed light on. The rating action from the S&P, as usual, comes with a significant lag as investors for years have wondered how the nation will pay its ballooning debt in the last ten years.

The U.S. debt shot up $5 trillion during the eight years of President George W. Bush to cover the expenses of two wars, medical drug plan for retirees and low taxes for the rich.

The recession that followed the lax supervision of banks and financial institution during the Bush era cost the nation another $2 trillion in various stimulus plans and lowered government revenues.

The rating agency cited the current lack of agreement among lawmakers and lack of willingness by a significant number of Republicans to let the Bush-era cuts end in 2012.

The decision was widely perceived as too little and too late as rating agencies failed to raise red flags in the last ten years when the cost of wars and the lack of new revenues contributed to the annual budget deficit over $1 trillion for more than six years in a row.

However, the rating agency decision was not without drama on Friday. In the early morning S&P informed the U.S. Treasury of its intension to lower its credit rating and presented its findings.

The Treasury officials noted $2 trillion in math errors that were related to long term assumptions, which the S&P agreed to and delayed its official announcement till 8 p.m. but left its downgrade decision unchanged.

S&P noted in its statement that the fiscal consolidation plan agreed by the Congress and the administration “falls short of” what would be “necessary to stabilize the government’s medium term debt dynamics.”

S&P followed up with another statement Saturday morning and said that the in the next ten years under the current revised assumptions “the net general government debt would be $20.1 trillion or 85% of 2021 GDP” and that debt level would have been “with the original assumptions of $22.1 trillion or 93% of 2021 GDP.”

The rating agency focused on not the government’s ability but its willingness.

The U.S. has lower debt-to-GDP ratio compared to several of the twelve nations that have the highest AAA rating. Only 25% of the government revenues are needed to pay for the annual interest payment of $225 billion, lower than many with the top rating.

The U.S. also has the ability to increase taxes for its richest citizens and cut military expenses and also cut some of the entitlement programs. A 4% increase in taxes for its highest earners will lower its debt burden over ten years by 20%.

However, in the current political climate the revenues increase through higher taxes are not likely for at least another year. The longer the government waits, more tax increase will be needed to fill the budgetary gaps, because lowering expenses alone will not solve the debt burden of $14 trillion.

China, Japan and Middle East central banks are not likely to change their holdings of the U.S. debt after the rating decision because most investors still consider U.S. bonds as a safe heaven.

Federal Reserve and Federal Depository indicated in a guideline issued after the downgrade that will not require banks and money market funds to hold more bonds or need more capital.

Also, on Friday, 10-year bond dropped to as low as 2.33% yield in New York trading. The U.S. bond yield is one of the lowest among the most developed nations only because there is no alternative to the safety of the dollar.

However the dollar’s power as the reserve currency is on the decline. According to the latest data available from the International Monetary Fund, said dollar as the global currency reserve declined to 60.7% at the end of March from its peak of 72.7% in 2001.

Most bond analysts are bracing for more no more than 0.05% to 0.1% increase in bond yield after the rating action.