Q&A: Standard & Poor’s Downgrade of the United States

What does the decision to downgrade the U.S. top-tier AAA credit rating mean?

NEW YORK - The United States lost its top-tier AAA credit rating from Standard & Poor's on Friday, a move that will affect the country's borrowing costs and investor opinion of U.S. assets. Here is a Q&A on what the downgrade means for investors, consumers and to the country.

How long has the U.S. had an AAA rating?
S&P has maintained an AAA rating on the U.S. since 1941. Moody's has had an AAA rating on the U.S. since 1917; Fitch's top-tier AAA rating dates to 1994.

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What is a downgrade?
Standard & Poor's, one of the three major credit rating agencies that assign scores to debt issued by institutions, municipalities, and governments, said there is a heightened degree of risk in holding debt issued by the United States. So it lowered its rating from the AAA, the highest possible level, by one notch to AA+. It also said the outlook is negative.

Why did it lower the rating?
The credit rating agency believes the outstanding debt of $14.3 trillion and projected deficits for coming years in the United States no longer warrant the top-tier rating that it had assigned to the United States since 1941. It also said that the political environment does not build confidence that the United States can agree on how to lower the deficit in a meaningful way any time soon.

Does this mean that U.S. debt is no longer safe?
No. At AA+, the U.S. is still considered to have a "strong" ability to meet its obligations. In fact, only a handful of countries now have the AAA rating - among them Canada, Germany, France and the United Kingdom. In addition, Treasuries have rallied this week, driving the yield on the benchmark 10-year note to 2.34 percent, its lowest level in about 10 months. This suggests people still view the U.S. as a safe place to invest.

But wasn’t a debt deal just signed in Congress?
Yes, but the savings from this are projected at $2.1 trillion. S&P has said that a larger level of savings is needed - at least $trillion either through spending reductions or tax increases - are needed in order to start lowering U.S. deficits in coming years.

What impact does the downgrade have?
Over time, a lower rating will cause investors who buy U.S. government debt to demand a higher interest rate to hold that debt to reward them for the risk. If that is the case, benchmark long-term interest rates will rise. Most major rates, including the debt of corporations, mortgages purchased by investors, and other types of loans, are priced in relation to the U.S. Treasury benchmark. That means borrowing costs across a number of spectrums over time will rise, making loans and bonds more expensive. The more an individual or company is devoting to interest payments, the less they have for other activities.

So what will it cost?
The downgrade could add up to 0.7 of a percentage point to U.S. Treasuries' yields, increasing funding costs for public debt by some $100 billion, according to SIFMA, a U.S. securities industry trade group.

Who owns U.S. debt?
Other than the U.S. Federal Reserve, the most recent data from the U.S. Treasury shows that China, with $.16 trillion in U.S. Treasury securities, is the biggest holder of the debt. China has repeatedly warned of the unsustainable trend of U.S. deficits and has talked of diversifying its holdings to other economies. But because China maintains the value of its currency through buying of U.S. dollars, it is likely to continue to be a major holder of Treasury securities for some years ahead.

Will my money market fund have to sell its Treasury debt?
Not likely. The credit rating change affects long-term debt - the short-term credit rating of the U.S. is A-1+, the highest short-term rating. Money market funds with short-term debt are unlikely to be affected.

Will investors prefer debt from higher rated countries?
This is possible. Some large investors, such as William Gross of PIMCO, have said other markets such as Canada offer more value. But the U.S. market retains significant appeal because its bond market was more than $35 trillion at the end of March 2011, according to SIFMA. No other bond market is close to that size.

Now this has happened, is U.S. safe from other downgrades?
No. To begin with Standard & Poor's has assigned a "negative" outlook to the U.S. long-term credit rating. That means another downgrade was possible in the next 12 to 18 months if it does not see an improvement in debt reduction.

The other ratings agencies, Moody's and Fitch, currently still have a AAA rating on U.S. debt, which they just affirmed. But both of those agencies have suggested the U.S. could also be downgraded if projected government deficits are not reined in. Moody's currently has U.S. debt on review for possible downgrade.