Standard & Poor's downgrade of U.S. credit rating and its implications

U.S. Bond Market

I agree with Standard & Poor's (S&P) downgrade of the U.S.'s credit rating. It was motivated by the fact that Congress and the Obama Administration had been unable to come up with a budget or fiscal plan that would stabilize the nation's medium-term debt dynamics. Furthermore, they cited serious problems with U.S. monetary and fiscal policy, which they felt left the United States very vulnerable in a time of high-volatility in the global financial markets (Paletta & Phillips, 2011). In other words, S&P was looking at the federal government's failure to come together and address the serious financial problems facing the nation and anticipating that this failure would lead to some type of gridlock. In hindsight, the nation has experienced exactly that type of predicted financial gridlock. The country is in significant debt and one party is opposed to raising taxes on those who can most afford the tax increase, even with offered cuts in spending. Even if all spending were eliminated, the debt will not be resolved without an increase in revenue, and there is tremendous opposition to any efforts to increase revenue. S&P was absolutely correct that the plans it had seen fell short of what was needed to stabilize the government's medium-term debts. Furthermore, it was correct in predicting that the government would not work together to develop a more comprehensive plan.

However, I also do not disagree with the decisions by those major agencies that retained the U.S.'s AAA rating. Country credit ratings are not like individual credit ratings, where credit just reflects the ability to pay a debt. Instead, a number of other factors can play into a company's credit rating, such as international goodwill towards the country and the role that the country plays in foreign economies. The United States plays a huge role in foreign economies, not only through global business practices, but through direct financial aid to those countries. In many ways, the U.S. economy has become too big to fail in some significant ways; it may experience recessions, but the global impact of widespread default by the U.S. On its debts would be so tremendous that it is highly unlikely that would ever occur.

Furthermore, U.S. investors have not responded to the downgrade in the negative fashion that one might expect. People predicted that lending rates would rise, and that the value of the dollar would fall. Instead, "mortgage rates have dropped to record lows, the government's borrowing costs have eased, the dollar and the benchmark S&P stock index are up, and global investors' enthusiasm for Treasury debt has strengthened" (Dorning et al., 2012). U.S. Treasury bonds remained the most traded in the world, and, the U.S. actually strengthened its economic position when compared to most of Europe. Furthermore, it is important to recognize the limitations of any of the major agencies in predicting the performance of bonds. "Almost half the time, yields on government bonds fall when a rating action by S&P and Moody's suggests they should climb, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as the 1970s" (Dorning et al., 2012). Therefore, it is difficult to assess whether or not the bond market's strong performance since the announcement is problematic. Investors seem to be ignoring S&P's warnings about the fragility of the U.S. economy, and there are some dangers related in that.