As Congress bickered through the month of July over whether or not to raise the U.S. debt ceiling, the clock was relentlessly counting down the hours to August 2, the date when the U.S. would theoretically run out of money and therefore default on its debt.
On July 14, Standard & Poor's, the ratings service, threatened to downgrade U.S. debt if an agreement was not reached and the nation defaulted. The other two major ratings services, Moody's Investors Services and Fitch Ratings, made no such threat and continue to rate U.S. credit at the top of the scale. (For more on bond ratings, read Bond Rating Agencies: Can You Trust Them?)
TUTORIAL: Bond Basics
Why the Downgrade?
An eleventh hour agreement to raise the U.S. debt ceiling was reached between Congress and the Obama administration but S&P nevertheless downgraded American government debt from the top-rated triple A negligible risk category to AA+, one step down from the best possible rating
Explaining their reasons for the downgrade, S&P was quoted as saying, "The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics.
S&P also cited the weak "effectiveness, stability and predictability" of the U.S. government's current handling of the crisis.
These comments were strictly opinions from S&P, and indeed, on the S&P website, it clearly states that, "Credit ratings are opinions about credit risk ... They express opinions about the ability and willingness of an issuer, such as a corporation, state or city government, to meet its financial obligations in accordance with the terms of those obligations."
Calculating a Rating
Certain proprietary mathematical formulae are also used in calculating ratings, and these were most likely used in S&P's decision to downgradeU. S. debt. But U.S. Treasury Department officials pointed out a $2 trillion error in S&P's calculation of project U.S. debt in the coming years.
Despite the alleged error, S&P stood by their downgrade. Markets domestic and worldwide reacted with an immediate plunge, then recovered somewhat but continued to be volatile in the immediate days after the downgrade, see-sawing down and up hundreds of points. The initial Dow Jones decline on August 8 was 634.76 points, the deepest one-day decline since December, 2008. (For more, see The Debt Ratings Debate.)
But sales of U.S. Treasuries – government debt obligations – were not affected and investors continued to buy the securities although interest rates did not go up. Fed Chairman Ben Bernanke, moreover, promised no increase in Treasury rates for the next two years, thus putting a lid on the widely anticipated expectation of a rise in interest.
Why Only One Downgrade?
Why Moody's Investors Services, and Fitch Ratings, did not downgrade U.S. debt, may be attributed to a more optimistic outlook on the part of analysts, differing equations for calculating risk, and/or other factors. Yet both firms warned that a downgrade may occur in the future. Neither firm, both business rivals of S&P, as of this date has offered a complete explanation of why they did not downgrade U.S. credit. Analysts have repeatedly mentioned that ratings could change instantly, depending of economic and other factors, both negative and positive.
The Obama administration strongly disputed the downgrade. Besides pointing out S&P's alleged mathematical error, mentioned above, U.S Treasury Secretary Timothy Geithner said, "They've [S&P] shown a stunning lack of knowledge about basic U.S. fiscal budget math."
President Obama, a probable candidate for re-election in 2012, made a more moderate statement. "Markets will rise and fall, but this is the United States of America," he said. "No matter what some agency may say, we've always been and always will be a triple-A country."
The Bottom Line
Obama did, however, acknowledge the severity of the problem. "My hope is that Friday's news [the downgrade] will give us a renewed sense of urgency," he said. It remains to be seen whether this urgency will affect the U.S. debt rating in the long term. (To better understand the bond rating system, check out Why Bad Bonds Get Good Ratings.)