Explainer: Your 5-minute guide to the S&P, U.S. credit rating and why it matters
When Standard & Poor’s Rating Service downgraded the United States’ credit rating from AAA to AA+ Friday night, Google searches on “S&P” and related terms surged. As people make sense of the latest developments, journalists may need to provide background on the agency and what it does. Here are the basics.
What is the S&P credit rating?
In 1860, Standard & Poor’s earliest incarnation was born as a way for Henry Poor to provide investors with accurate information about corporations. The first credit ratings were published in 1916.
Standard & Poor’s gave its first credit rating to the United States in 1941. The AAA rating matched the one given previously to the government by S&P’s predecessor institutions, Standard Statistics and Poor’s Publishing. It temporarily downgraded the outlook to “negative” following the attack at Pearl Harbor.
The credit rating is Standard & Poor's opinion of a creditor’s ability to meet its financial obligations, including its debt.
(Note: The credit ratings are unrelated to the S&P 500, which is the company’s index of stock prices.)
Why did S&P downgrade the U.S. credit?
Standard & Poor’s says “political brinkmanship” has endangered the government’s ability to make sound financial decisions, as demonstrated by the debt-ceiling debate:
“...we see ... America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently.”
S&P cites the lack of new revenues and economic growth. It also expresses concern about containing the costs of Medicare and other entitlement programs, “which we and most other independent observers regard as key to long-term fiscal sustainability.”
S&P's explanation suggests lawmakers lack the wherewithal to reach consensus about public finances, which may transcend current officeholders:
“A new political consensus might (or might not) emerge after the 2012 elections, but we believe that by then, the government debt burden will likely be higher, the needed medium-term fiscal adjustment potentially greater, and the inflection point on the U.S. population's demographics and other age-related spending drivers closer at hand.”
Will the S&P upgrade the U.S. rating?
Given the explanation for the downgrade, it seems unlikely that an upgrade will come anytime soon. In April, S&P changed the rating’s outlook from stable to negative. And in the latest change, the company notes that it “could lower the long-term 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 in our base case.”
The downgrade report said S&P would respond favorably if lawmakers let the Bush tax cuts of 2001 and 2003 lapse, which Republicans have indicated they hope to extend.
How does the U.S. S&P rating compare to other countries?
S&P says the U.S. long-term credit rating is diverging from the AAA ratings of Canada, France, Germany and the U.K. The projected ratio of debt to gross domestic product this year ranges from a low for Canada to a high for the U.K., with the U.S. close to the high. However, S&P projects the public debt of these other nations to decline by 2015, while the U.S. debt continues to climb.
Is S&P’s the only credit rating?
Moody's Investors Service and Fitch Ratings are recognized, with the S&P, by the Securities and Exchange Commission. Both Moody’s and Fitch continue to give the U.S. a AAA credit rating.
How credible is the S&P rating?
Since the downgrade announcement, critics have questioned the S&P's credibility, particularly for "miscalculations in assessing mortgage bonds before the financial crisis." Treasury Secretary Tim Geithner also questioned S&P's math and judgment in its decision to downgrade the U.S. credit rating. The agency stood by its decision.
Why does the S&P rating matter?
The downgrade is a symbolic vote of less confidence in the government’s ability to pay its debt.
It had real consequences, though, as on the first day of trading after the downgrade, Wall Street had its worst drop since 2008.
The U.S. credit rating was not the only one dropped. On Monday, the S&P also dropped the ratings for Fannie Mae and Freddie Mac, government-backed mortgage holders.
Just as with individual credit ratings, a higher one often means paying lower interest rates. “The previous top-notch AAA credit rating meant the U.S. pays lower interest on its $14.4 trillion in debt," MSN Money reports. "With a downgrade, the country would likely pay slightly higher interest rates on its debt."
And the government won’t be the only one paying higher interest rates. Consumer loan rates usually follow the government’s rates so interest rates on car, home and student loans could increase as well. This increase would be a bitter pill for an ailing economy to swallow.
It could affect other investments as well, Forbes reports:
A ratings downgrade would have negative implications for debt issuers whose credit strength is directly linked to the federal government. This includes debt guaranteed by the federal government, like money market funds and bank CDs, and the obligations of government agencies like Ginnie Mae, Freddie Mac and Fannie Mae mortgage debt. A downgrade could limit investor demand for US Treasuries as fund managers rush to buy other triple A rated debt, or hard assets and commodities, mainly gold.
Clearly, there are political implications -- national and international. Japan, France and Australia affirmed their faith in U.S. credit, and China -- which holds 8 percent of our country’s debt -- has spoken out against our country’s “addiction to debt.” The state-run news agency of China says the U.S. is "letting its domestic electoral politics take the global economy hostage."
In the U.S., President Barack Obama and Congress may face increased pressure to address the country’s long-term financial outlook in the next round of budget negotiations. Speaker of the House John Boehner responded to the downgrade by emphasizing the need to rein in “out-of-control spending.” Senate Majority Leader Harry Reid emphasized the need to seek new revenue. Both positions are consistent with their approach to the debt-ceiling debate, which is what led the S&P to downgrade the U.S.'s credit rating.