History will show that in the summer of 2011 our country was gripped by a contentious debate over our nation’s debt ceiling and the need to curtail our spending. This battle promises to be a regular event on the calendar, as the issues involved will probably outlast you and me before they’re fully resolved. Although the Congress was able to come to an 11th-hour compromise, the constant back and forth did little to settle our ongoing economic problems. Among the challenges we continue to face are a slowing rate of manufacturing growth, weak consumer spending, persistent long-term unemployment, and the continued deterioration of the housing market. Perhaps the last thing we needed was a downgrade of our pristineU.S. sovereign credit rating, which was dropped to AA+ from AAA, a rating we had held since 1917.
Investors understand that theUSwill not default on its obligations; however, the bickering between elected officials indicated something many in the personal finance world have known for some time – you cannot spend your way out of debt. If anything, the political wrangling did each of us a profound disservice. Among the reasons Standard and Poor’s choose to downgrade our credit rating was the perception that Washington has become, as S&P termed it, “less stable, less effective, and less predictable than what we previously believed.“ Obviously, Republicans and Democrats have condemned the downgrade, but is their criticism because the S&P move was uncalled for, or because it makes the job of our leaders that much more difficult?
The S&P credit rating is essentially our nation’s “credit score.” Similar to an individual’s FICO score, this rating is reviewed to determine the nation’s creditworthiness, or capacity to repay its obligations. No matter where you fall along the political spectrum, there is no denying that we have a spending problem inAmerica. Almost 40 cents out of every dollar we spend is borrowed. For this reason alone, a drop in our credit rating seems justified.
Now, the debt ceiling debates did bear some fruit, and the measures enacted will help to decrease our growing deficit. Initially, the agreement calls for a reduction of $2.4 trillion in spending over 10 years. The current plan has identified $917 billion in savings, and another $1.5 trillion will be identified by the congressional Joint Select Committee on Deficit Reduction, the “super congress” that has been discussed in the media. Unfortunately, these measures do not meet the criteria established by Standard & Poor’s that would have helped us avoid a downgrade. S&P advised Washingtonthat lawmakers’ would have to identify at least $4 trillion in cuts and revenue increases over the next decade. Because the Congress doesn’t seem able to compromise on this point, we received an AA+ rating from the agency.
On a personal level, I’m no fan of Standard & Poor’s, since they and the other rating agencies didn’t hesitate to give mortgage-backed securities AAA ratings, a factor that contributed to the economic collapse of 2007 and 2008. Yet some financial experts say the downgrade doesn’t necessarily spell economic doom. After all, both Japan and Canada emerged stronger about a year after being downgraded. Then again, Standard and Poor’s is not known for its accuracy. The mortgage fiasco aside, S&P has been slow to downgrade the ratings of countries that were in far greater peril than our own. It took S&P almost three years to downgradeIreland, long after the world knew of that nation’s financial problems. S&P was also slow to react to Spain,Iceland, andGreece– which we have heard a lot about over the last few months.
The point is that this is not the end of the world; however, perception is reality. Although theU.S.represents no real risk of defaulting on its debt, the downgrade may have a psychological toll on Americans, on investors, and on lenders, causing a slowdown in our already anemic recovery. Consumer and investor confidence could take some time to return, and we still don’t know how many twists and turns are left in our rollercoaster economy. At the end of the day, our downgrade remains largely symbolic; however, it has brought our fiscal problems out into the open. We’ll bring you more insight as to how the change inAmerica’s credit rating will affect you more directly in upcoming installments. Until next time, I’m Thomas Fox for Cambridge Credit Counseling.