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US stripped of AAA credit rating by S&P over political weakness

The US government's credit rating has been lowered to AA+, the first downgrade in modern US history, despite furious lobbying

Guardian

The credit rating agency Standard & Poor's has stripped the US of its top-notch AAA credit rating, downgrading it to AA+ and warning of further future downgrades because of political and economic uncertainty.

The humbling downgrade of the world's economic superpower came late on Friday night, after news surfaced of a furious rearguard attempt by the White House to convince S&P that its calculations were flawed.

The justification used by S&P – blaming the dysfunctional US political system for being unable to make significant fiscal reform – will set off another debate about US government spending and the shambolic process to raise the debt ceiling that ended earlier in the week.

In particular, the news may force Republicans in Congress to reconsider measures to raise revenue – and strengthens President Obama's hand in any plans to allow the Bush-era tax cuts to expire, raising an additional $3tn over the next decade.

S&P's decision shifts long-term US sovereign debt to the same level as Britain, Japan and New Zealand – but below that of Canada, Australia and France.

As a rule, a lower credit rating means higher borrowing costs for debtor nations. But because of the size of the US and its deep capital markets – and its crucial role as cornerstone of global finance – it remains to be seen exactly what impact the move will have when financial markets reopen on Monday.

One big question will be the reaction of foreign investors, such as China. But most analysts expect the short-term impact to be muted.

"One of the reasons we don't really think foreign investors will start selling US Treasuries aggressively is because there are still few alternatives to the US Treasury market in terms of depth and liquidity," Vassili Serebriakov, currency strategist at Wells Fargo in New York, told Reuters.

Reaction from both politicians and financial participants was swift, after the initial shock of the late announcement wore off.

The Federal Reserve announced that US government securities such as bonds would still be counted as AAA-rated under risk management regulations, an important decision for insurance companies and other investors who would otherwise have been faced with making massive movements in their portfolios.

Republicans were quick to highlight the downgrade – the first since S&P awarded AAA status to the US in 1941 – as a humiliation for President Obama.

But S&P's statement explaining the move blamed both parties for the US fiscal mess – and had harsh words for the Republican party for ruling out any taxes increases.

"We have changed our assumption ... because the majority of Republicans in Congress continue to resist any measure that would raise revenues," S&P said.

S&P also said the budget savings agreed by Congress at the start of the week were too feeble, and blamed political weakness and instability for triggering the downgrade:

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon.

The credit rating agency also said the outlook on its long-term rating was negative, warning that it could lower the long-term further rating to AA within the next two years "if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume".

S&P notified the US Treasury on Friday afternoon that it was planning to lower the credit rating, according to government officials, and the company sent a draft of its analysis to the White House.

White House officials then claimed to have discovered a $2tn-sized hole in S&P's calculations, and briefed journalists. But it failed to wring a delay out of the agency, which went ahead with the downgrade.

Earlier this week, the other two major credit rating agencies, Fitch and Moody's, reaffirmed their versions of AAA ratings after the end of the debt ceiling fight. But Fitch also said it was keeping the US rating under review until the end of August.

After a week of plunging financial markets, the S&P downgrade will do nothing to calm nerves of jittery investors when Wall Street opens on Monday morning. The downgrade will likely be followed by a series of downgrades of debt issued by government agencies, such as mortgage giants Fannie Mae and Freddie Mac.

SIFMA, a US financial industry trade group, estimates that the downgrade could add up to 0.7 of a percentage point to the yield (interest rate) of US government bonds, increasing the cost of servicing public debt by $100bn.