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S&P downgrades U.S. credit rating

06 Aug

Expectations of such a move after Friday’s close helped pummel stocks in morning trading. Here’s what it could mean.

As many had expected, Standard & Poor’s finally decided to cut the U.S. credit rating late Friday. The world’s largest economy lost its perfect AAA status, tumbling by one notch to AA-plus.

The decision came after a day fraught with twists and turns, keeping everyone from President Barack Obama to individual investors on pins and needles. Rival ratings agencies Moody’s and Fitch had already said they wouldn’t downgrade the U.S., leading some observers to predict that Standard & Poor’s wouldn’t go solo on such a controversial position.

But others thought a downgrade was inevitable, particularly after S&P placed the country’s perfect AAA credit rating on “CreditWatch negative” on July 14. That status generally means the agency will make some ratings move within 90 days. The rumor was resonant enough that it helped punish stocks in early trading Friday.

S&P notified the Treasury Department early Friday afternoon that the downgrade was coming, The Wall Street Journal reported, but Treasury officials looked at the numbers and found that S&P had miscalculated future deficit projections by nearly $2 trillion.

S&P reportedly agreed it had made a mistake. But then it went ahead with the downgrade anyway.

For the U.S., losing that perfect rating could have an impact on interest rates nationwide. It may ruin the country’s global reputation as the safest investment option. And it could damage the American psyche — wait, we’re not the best in the world?

Now that the downgrade has taken place, here’s how the country and its consumers could be affected:

Interest rates: The previous top-notch AAA credit rating meant the U.S. pays lower interest on its $14.4 trillion in debt. With a downgrade, the country would likely pay slightly higher interest rates on its debt.

That would also hold true for consumers, as interest rates on consumer loans generally pace government debt (often the 10-year Treasury). Home mortgages, car loans, bank loans and other debt would likely carry higher rates.

Stock market impact: More observers are starting to think there wouldn’t be much market response to a downgrade. That’s because U.S. pension funds, insurance companies and other large investors are generally not required to hold AAA-rated debt, Reuters reports. They have some flexibility and likely wouldn’t be forced into action.

It’s generally expected that investors would pull $40 billion out of U.S. Treasurys if the downgrade takes place. That’s practically nothing, considering there are about $10 trillion in tradable U.S. bonds, experts say.

Global response: Well, not much. Even S&P executives say global markets have already discounted to the potential risk of a U.S. downgrade.

Political impact: No politician wants to see a credit downgrade on his or her watch. It would be a source of embarrassment for President Barack Obama and members of Congress. And a downgrade would add more pressure on lawmakers to cut the deficit, which Fortune says will stall economic growth.

Dollar: There’s a reason people worldwide buy the dollar and store their savings in U.S. dollars. It’s widely been considered the safest option, a stable currency in any event.

That would change. People wouldn’t be as keen to buy the U.S. dollar, and already they are turning to Australia, Germany, Austria and other countries for haven investing. The dollar could lose its status as the world’s reserve currency.

At any rate, some Americans are taking a rather defiant stand. Go ahead and downgrade the U.S., they say. It will survive. We don’t need to quiver in fear as the ratings agencies threaten us. Who even needs ratings agencies, anyway?

U.S. economist Zachary Karabell put it this way: “The best possible outcome would be for them to downgrade the U.S. — and for the world to shrug, with rates set by the multitude of buyers and sellers. That would at least demonstrate that these emperors, clothed though they are, wear very frayed robes.”

Another economist, Tyler Cowen, says he’s not sure how the markets will respond and he doesn’t think an alarmist reaction about the market is appropriate. “A letter grade is a letter grade and the facts on the ground did not change today,” he writes. “It may or may not lead to a major sell-off. Still, years from now today may well be seen as a turning point of significance.”

By Kim Peterson on Fri, Aug 5, 2011 2:03 PM
Updated 8:30 pm ET

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