Thursday, September 29, 2011

Have We Already Begun Feeling the Effects of an S&P Downgrade?

Courtesy of David Prior/Flickr Images 

Last month, the well-known and also highly criticized credit rating agency, Standard and Poor's downgraded the United States' AAA credit rating to AA+: an unprecedented move by the organization to say the least. The U.S. has held on to its top-notch credit rating for the past 94 years and in keeping with the succession of historic "firsts" that have donned our country since 2009; the first time an African American is elected as President; the first sweeping piece of health care legislation is passed since the 1960's; and the first time members of the Tea Party Movement are elected to serve in Congress, S&P downgraded the country's credit rating for the first time in the ratings' history.

Reasons for the downgrade? The U.S. long-term debt to GDP ratio continues to increase, the plan lawmakers agreed to, according to S&P, doesn't do enough to "stabilize the government's medium-term debt dynamics," and the likelihood of any sort of resolution in Washington devised solely by the two political parties to bring down the debt seems ominous. In addition, S&P's outlook on America's long-term rating is negative, which means that if the Administration and Congress fail to put substantial measures in place to lower spending, among other things, we could see our credit rating lowered further to 'AA' in the next two years.

So what should Americans expect after the nation's first fiscal mark down? Ironically, S&P offers that the effects of the downgrade will surface in the form of slower economic growth amid consumer fears. The downgrade could also potentially raise borrowing costs for the U.S. government. However, FDIC-backed accounts, money market funds and such wouldn't see a huge change. Car loans could potentially rise but very little. Most mortgage rates should continue to fall, while ARM's are poised to go up. Federal student loans would remain fixed, while a student who has taken out a private student loan could see higher borrowing costs. In the case of credit card companies, it's not surprising that they could likely raise their interest rates regardless of the downgrade.

Investors believe U.S. treasury bonds are still a good investment option. In fact, discussions are under way among Federal officials as the agency deliberates buying long-term treasury bonds to help boost the economy. The Washington Post reports: "The Federal Reserve is moving toward new steps aimed at lowering interest rates on mortgages and other kinds of long-term loans, without making another massive infusion of money into the economy." This latest potential move by the Fed would reportedly lower interest rates, reduce mortgage rates, and make it cheaper for businesses to borrow money. Still, the general sentiment within the financial sector is that U.S. Treasury bonds are still among the safest in the world. According to Peter Crane, president of Crane Data, "Double A will become the new triple A, because their simply isn't a viable competitor to Treasuries."

Many Americans have already experienced the more tangible effects of the downgrade. Oil prices fell almost 20% after S&P's announcement and according to, "It touched the lowest levels in almost eight months ." Initially, we witnessed lower prices at the pump, but in the last two weeks we've actually seen a significant increase, depending upon which region you live in.

The U.S. dollar continues to take a hit in light of the mark down, but still remains a safe-haven for many. S&P has also downgraded the debt of government-backed mortgage behemoths Fannie Mae and Freddie Mac; the jury is still out on whether S&P's latest move will affect mortgage rates. As expected, gold prices continue to hit record highs and some experts predict that we will see gold peak to about $2,075 by 2012.

As anyone who watches the stock market knows, it's been pretty volatile over the past month to say the least: clearly, a sign of the times. To add to the chaotic financial environment, no one really knows what to expect since the United States' credit has never been downgraded before. Some argue, however, that just as in the case of countries such as Canada and Japan, stocks had initially lost some traction once these nations had been downgraded, but subsequently ended up gaining more within a year's time.

Even before the U.S. lost its triple-A credit rating, there was a growing sense within the financial markets and beyond that people had begun moving toward being less dependant upon credit ratings agencies like Standard and Poor's, Moody's, and Fitch. The entire financial debacle of 2007 and the nation's recent S&P downgrade have solidified that.

The purpose of credit rating agencies is to determine the financial strength of a business based on its financial history. A letter rating is then given based on the organization's capacity to meet its debt obligations. Just like anything else these entities are prone to miscalculations, bias, or inaccurate information. Reflecting on the different causes of the financial meltdown back in 2009, Lloyd Blankfein, CEO of Goldman Sachs, stated that, "Too many financial institutions and investors simply outsourced their risk management. Rather than undertake their own analysis, they relied on the rating agencies."

More recently, the Treasury Department pushed back on S&P's downgrade of the U.S. sovereign credit rating citing that S&P had "acknowledged an "error" in its calculations and that the rating company made a $2 trillion mistake." Still, S&P continued in its rationale for the downgrade. Acting assistant secretary for economic policy, John Bellows, speculates that in the end the organization's reasoning for the downgrade had shifted from economics to politics: "After Treasure pointed out this error," Bellows wrote, "S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one."

The bright side? Congress will finally be FORCED to get something done. But whether or not they do still remains a question. The debt ceiling deal both Congress and the Administration agreed to included an initial $917 billion in spending cuts over 10 years, while giving the charge to a bi-partisan committee of 12 members the next-to-impossible task of searching for another $1.5 trillion in cuts by November 23 or face a pain-staking $1.2 trillion in across-the-board cuts, beginning January 2013. Yet another incentive to reduce spending is the nation's current negative outlook by not only S&P, but Moody's as well.

Many lawmakers on both sides of the isle acknowledge that the way Washington has handled its finances in the past is null-and-void moving forward. Whether it's fueled by what many have viewed as conservative fiscal extremism by the Tea Party or quite simply the economic sinkhole we've found ourselves toppled over into: the voice and tone of Washington and the way we do business will most likely be changed forever: "For decades, political careerism has trumped statesmanship in Washington," says Republican Senator, Tom Coburn. "Both parties have done what is safe, not what is right. The dysfunction in Washington is the belief that we can live beyond our means forever. We can't."