The decision of Standard & Poor's, one of the top three rating agencies, to downgrade, for the first time ever, its rating of U.S. government long-term debt by one notch from ‘AAA' to ‘AA plus' is a historic one and highlights the diminished fiscal stature of the world's number one economy. The rating agency has said the unseemly political controversy and discourse that almost forced the federal government to default has lowered the standing of the U.S. “The gulf between the political parties” has undermined S&P's confidence in the government's ability to manage its finances. Few will question its view that the effectiveness, stability and predictability of American policy-making and political institutions have weakened at a time when fiscal challenges are persisting. Worse, the long-term outlook remains negative: another downgrading is possible within the next two years if the reduction in spending is less than that agreed to recently under the ceiling deal, or if there is a rise in U.S. interest rates or if the debt increases further.
Since the S&P's announcement came after the markets closed on Friday, one has to await their opening on Monday to know the range and intensity of the impact of the downgrading on the stocks at the global level. Given the vulnerability of the U.S. economy, the bond yields are bound to soar immediately. The borrowing costs of the federal government, and many institutions linked to it such as the housing mortgage companies, Fannie Mae and Freddie Mac, will go up. That will be bad news especially for the U.S. housing sector, which was at the centre of the last financial crisis and whose revival is a sin quo non for general economic recovery. Since the federal government incurs some $250 billion by way of interest payments every year, even a small hike in rates will inflate the deficit. There will be more clamour for an alternative global reserve currency, although the downgrading by itself does not significantly alter the current situation where the dollar holds sway for want of a real contender. The other two major rating agencies — Moody's and Fitch — are not reviewing their ratings at least for now, and this, the analysts say, may help contain the impact of the S&P decision. The credit rating agencies themselves are trying hard to win back their credibility that took a beating during the global financial crisis which saw highly-rated complex mortgage securities collapse. While it is difficult to anticipate all the consequences of the downgrading of the U.S. government's long term debt, there is little doubt it will add to the existing uncertainty and make recovery that much more difficult.