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What the U.S. Credit Rating Actually Means—And How to Fix It What the U.S. Credit Rating Actually Means—And How to Fix It

What the U.S. Credit Rating Actually Means—And How to Fix It

by Tim Fernholz
August 7, 2011

After an afternoon of contentious wrangling over the numbers, Standard & Poor's, the global bond rating agency, declared Friday for the first time since 1917—when the company issued its very first rating—that U.S. government debt is no longer the good-as-cash investment it has always been. The agency knocked the rating down a notch from AAA to AA+. This is bad news, but specific repercussions will be hard to pin down until the markets open Monday morning. (The two other major ratings agencies still say that U.S. debt is AAA. )

You might be asking, didn’t we just spend six months trying to avoid this very situation, and pass a last-minute deal to prevent it?  It turns out that fractured and ineffective political process is  actually what inspired the S&P to throw up its hands.

Why does our credit rating matter, anyway? Ratings agencies measure two broad things: A borrower’s ability and its willingness to repay its loans. The United States is still an enormously rich country, with low tax rates and growing (albeit slowly growing) economy. We can pay our debts, and there is a cottage industry of policy wonks producing very credible plans on how to do just that. Our ability to repay isn't the issue.

Our issue is willingness, and particularly the willingness of our government to adopt one of those plans. Intransigent Republicans were called out by name in the S&P’s statement on the downgrade for their refusal to consider raising taxes. The S&P no longer assumes that the White House will effectively be able to let the Bush tax cuts expire on schedule at the end of next year, an indictment as much of the Democrats and President Obama as much as the GOP.

How do we fix it? At the broadest level, our politics has come down to a conversation about whether the country will continue in the path of other developed nations around the world, raising taxes and reforming systems to preserve a social safety net and a hybrid economy, or if we’ll shift toward austerity and shed many of the things our government does to provide security to its citizens, letting corporations and markets sort things out. Right now Americans—and the politicians we elect—can’t make a decision between those two courses. Simply choosing one would satisfy the debt agencies. Instead, we’re stuck in limbo, trying to run a modern state without actually funding it.

On Friday, the S&P issued a serious warning to the government that it’s time to stop dicking around and make some decisions. Will lawmakers rise to the challenge and strike a real bargain? The answer depends on your personal cynicism level. It's telling, though, that when the White House offered Republicans in Congress the $4 trillion deficit reduction plan the S&P favored, which leaned heavily on spending cuts and barely raised taxes, the GOP wouldn't take yes for an answer.

What happens next? The near-term effects could be very, very bad. On Monday, the markets will be in chaos as investors react to this negative assessment of the managers of the world’s biggest economy. If Treasury rates increase—which is among the likelier outcomes—we’ll see the costs of everyone’s mortgage, car, and student loans increase, and our economic growth will constrict further.

Equally troubling, on Monday, S&P will announced credit ratings changes for a number of states, cities and organizations that are dependent on U.S. treasuries.  Borrowers ranging from the state of New Mexico to home-loan giants Fannie Mae and Freddie Mac could see their borrowing costs increase, leading to cascade of effects across the country. Perhaps the worst-case scenario is that it will be even harder for policymakers to balance the budget because the country’s interest payments will increase so much.

The most important thing to remember is that this isn’t a financial problem, it’s a political one. The only other country in the world that has an S&P AA+ rating is Belgium, a country facing its own intractable political discord because of a struggle between the country’s two major ethnic groups. Belgium holds the world record as the state that has gone the longest without a functioning government. Looking toward Washington, it seems our elected officials are doing their best to give them a run for their money. 

Photo (cc) via Flickr user The White House.

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