America's Credit Downgraded: What You Need to Know

Rumors were swirling all day, and then it finally hit: Standard & Poor's downgraded the nation's credit rating Friday evening, the first time the U.S. Treasury has lost its pristine AAA rating since ratings began nearly a century ago.

S&P now rates the United States at AA+. The rating agency didn't beat around the bush when describing why it made the cuts:

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. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

No big surprises here. The rating agencies have had the nation's credit rating on notice for months, warning Washington that without getting its fiscal house in order, and keeping political cage matches away from serious economic issues, a downgrade loomed. The debt-ceiling deal struck earlier this week failed on the former, and made the latter go prime-time. So here we are.

What's it mean for markets? No one can say for sure. Some sort of visceral fear-laden response on Monday seems likely. If there is a big selloff, it's not just about investors panicking. It's about investors expecting that other investors will be panicking and trying to preempt them. Do yourself a favor and don't pay much attention to any dramatic market reactions next week. The traders and computer algorithms that influence daily market moves almost certainly have different goals from the average Motley Fool investor.

Longer-term, the downgrade could mean a jump in interest rates. That could slow economic growth and literally add trillions of dollars to the national debt in higher borrowing costs.

This, though, is debatable. On average, AA-rated countries pay about 0.7% more to borrow than AAA-rated ones. But there are exceptions. Japan's interest rates actually fell after it was downgraded in 2001. The United States issues (or used to issue) about 60% of the world's AAA-rated debt. Investors who want high-quality debt in large amounts don't have many choices besides Treasuries. In that case, the downgrade might have little impact. It might just mean that AA becomes the new AAA. This is the argument that those who think the downgrade will be a nonissue use, and they very well may be right.

How did we get here? Federal debt exploded over the past few years as the recession smashed the economy:


anImage

Sources: Federal Reserve, author's calculations.

Interestingly, though, interest rates have plunged so deeply that even as debt accumulated, total interest paid on that debt -- what I've argued is the most important figure when looking at the national debt -- has dropped to nearly a historic low:

anImage

Source: Office of Management and Budget.

And as S&P hints at, the rise in debt in recent years has been caused almost as much by a drop in tax revenue as it has a jump in spending:

anImage

Source: Office of Management and Budget.

Silver lining: Let's hope this serves as a wake-up call.

At the time this article was published Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter, where he goes by @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Small Cap Investing

Learn now to invest in small companies the right way.

View Course »

Income Investing

Grow your nest-egg.

View Course »

Add a Comment

*0 / 3000 Character Maximum

1146 Comments

Filter by:
james

Hi, I must say that you have made some good points in the post. I performed searches on the topic and found most people will agree with your blog. Thanks for sharing this information.
I always like your blog post because you always come with different ideas and information. I always shared your site post with my friends. Keep posting and i will follow you..
http://raspberryketones.blogspot.com/

September 15 2011 at 12:32 AM Report abuse rate up rate down Reply
mzharleywood

It is heart-breaking. We have the most beautiful country in the world but we have allowed our government to operate on the verge of insanity. Beam Me Up Scotty.

August 08 2011 at 6:33 AM Report abuse +2 rate up rate down Reply
toosmart4u

Lets face the facts. The bush administration with their tax cuts for the rich, their two wars and their spending along with their fiscal policies have continued to chalk up the debt. The bush administration received a surplus of taxes from the Clinton administration and turned it into a hugh deficit. Now the republicans control the purse strings and look what we now have, nothing genuin. For a better America we must send the GOP home in 2012.

August 08 2011 at 4:41 AM Report abuse rate up rate down Reply
4 replies to toosmart4u's comment
bubwalt

10 years ago we had budget surpluses. What happened? Tax cuts for the rich and corporate america destroyed our way of life. Looks like we will have to sell Alaska to China to get out of debt. Thanks to the Bush Tax cuts!!!!!

August 08 2011 at 4:12 AM Report abuse -3 rate up rate down Reply
1 reply to bubwalt's comment
hpemailme

bub - THERE WAS NEVER A SURPLUS- the Clinton surplus was a myth - PLEASE CHECK YOUR FACTS BEFORE POSTING - POST THE BUDGET-IT IS AVAILABLE -DO YOUR RESEARCH BEFORE YOU JUST REPEAT PROPAGANDA

August 08 2011 at 7:06 AM Report abuse -1 rate up rate down Reply
terryw1948

It's time to go back to the basics, first lets cancel any and or all poliricians percs, and special programs the followiong ends tomorrw.
1. no free medical for any politicain, they participate in whatever program they create for us they participate in, no exceptins..

2. anyone recieving a rtirement plan from participating in or having participated in either the congress or the house of representatives ends tomorrow they recieve only social security.

3. Term limits noone can serve more than two terms in either the house or congress, and if they have already served a term exceeding that limit their term will end with the next election. They can not run fro re election and there government service is over for life.

4. wether you serve in the house or the senate your pay is $100,000. a year period. no perks of any kind.

5. The entire tax code is vacated and the IRS is eliminated. Individuals and companys are now on a straight 25 % of their income. no excemptions.

6. all lobyiest are banned from any government building, any former congresman or representative who is now working for any company that had a lobiest, has one week to quit and any present congressman or representative who goes to work for any company with a lobiest after his government service will be immediately arrrsted and charged with political corruption.

7. any politicain who is found to have recievied anything of value from a pac group, or to have benifited, during or after his sevice, from any pac group, or lobbiest will be immediatly arrested, and all their assetets seized. upon conviction all his assesstes are to be turned over to the federal budget and deposited into the general fund for the benifit of the American people.

8. no person can spend more than 1 million dollars in their, or their party's sponsorship, in any election. private contributions can not exceed $1.00 per individual and corporation can not contribute anything, to anybody running for any politial office.

9 any slush funds existing tomorrow for the intended use towards the election campaigne of anybody, that exceeds one million dollars,the amounts over one million dollars will be immediately siezied and deposited into the federal governments general fund, for the benifit of the American people.

10. If an elected official is caught telling an obvious lie, to spin a fact for their personal benifit, they will be immediately fired.

August 08 2011 at 1:10 AM Report abuse +8 rate up rate down Reply
Ed

Funny how the deficit under Regan and Bush was no big deal. Now with a black democratic president it's the biggest thing in the world. Let's face it the US is still a racist slave operating country. We killed the Indians off and then brought blacks here to do the work now we want communist China to do the work and the middle class to work for less than 40,000 with no benefits. Man the right got a great game going religious fanatics support them because there afraid of going to hell and the poor have no voice at all. What is the white man going to do when the population out numbers them in fifty years. I guess the gas chambers again. By the way I'm white but believe in the truth.

August 08 2011 at 1:03 AM Report abuse -3 rate up rate down Reply
2 replies to Ed's comment
icemanbill23

You lie Ed, you don't "believe in the truth" and you're not white.

August 08 2011 at 1:52 AM Report abuse +4 rate up rate down Reply
hpemailme

ED - PUT YOUR RACE CARD AWAY- IT DOESN'T WORK ANYMORE- THAT IS A POOR EXCUSE FOR THE DOWNFALL OF AMERICA UNDER AN ANTI-AMERICAN PRES.

August 08 2011 at 7:08 AM Report abuse rate up rate down Reply
alucky1128f8@aol

GOODNIGHT, MRSPELOSI ,I PRAY YOU HAVE A BLESSED WEEK MY FRIEND.

August 08 2011 at 12:23 AM Report abuse -1 rate up rate down Reply
alucky1128f8@aol

GOODNIGHT AND GOD BLESS ALL MY CONSERVATIVE FRIENDS !!!!!. 2012 LOOKS REAL GOOD FOR US, AMEN !!!!!.

August 08 2011 at 12:14 AM Report abuse +2 rate up rate down Reply
alucky1128f8@aol

MIKE, BEDTIME AND TAKE YOUR GOLD WITH YOU.

August 08 2011 at 12:11 AM Report abuse rate up rate down Reply
alucky1128f8@aol

I KNOW THINGS ARE REALLY BAD WHEN THE LIBERALS STOP BLAMEING BUSH AND START BLAMING THE AMERICAN PEOPLE. YOU LIBERAL DEMOCRATES ARE DINGBATS !!!!!!!!. WE WILL HAVE A CONSERVATIVE IN THE WHITE HOUSE IN 2012 !!!!!!!.

August 07 2011 at 11:41 PM Report abuse +2 rate up rate down Reply