Would You Lend Money To Uncle Sam?

By Douglas Rice | May 28, 2009 AAA
Would You Lend Money To Uncle Sam?

Recently, the credit quality of the United States has come into question as rumors of a downgrade by the credit rating agencies have resurfaced. Last year, as the crisis took shape, some of the ratings agencies raised the possibility of a credit downgrade of the U.S., but nothing materialized. But with mounting debt, deficits for as far as the eye can see and the financial crisis more stubborn than anyone would like, it might seem a bit more risky than it used to be to loan our hard-earned money to Uncle Sam. (Read more in Why Country Funds Are So Risky.)

Because governments offer securities in the open market, the credit agencies analyze the risk of the country and issue ratings so investors have some guidance as to how risky it is to loan those countries money. Just think of it like your own credit score. If you pay your bills on time, have a stable job and not too much debt, your rating is high; if not, it's lower. In fact, many countries have low credit ratings. But the U.S. has had the highest possible credit rating (AAA) basically forever. A downgrade would be historic.

Could this really happen? The UK has already been hit by a decision by Standard & Poor's, a major credit rating agency, to drop the medium term outlook on the UK's AAA credit rating from "stable" to "negative." The reason given was the high level of debt and the lack of a plan to reduce it. Sound familiar? This is basically where the U.S. is headed unless something changes. So, yes, it's possible.

The main implication of a credit downgrade is higher interest rates because investors would require compensation for the higher risk. Some may even shy away from loaning us money. This would not only increase the amount of our tax dollars going to pay down interest on the debt, but would push up other interest rates as well, making borrowing for consumers and businesses more expensive. But that's not all of it. It's also likely the value of the dollar would fall, making imports more expensive, and raising commodity prices. There's no advantage to bad credit. (Make sure your personal credit is in order, read Check Your Credit Report.)

Would you lend money to Uncle Sam? Sure, but at what price (interest rate)? Just like your own personal credit score, the U.S. government and us taxpayers are far better off with a stellar credit rating.

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