06/08 S&P downgrades U.S. credit rating for first time

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By Zachary A. Goldfarb, Updated: Saturday, August 6, 12:14 PM

Standard & Poor’s announced Friday night that it has downgraded the U.S. credit rating for the first time, dealing a symbolic blow to the world’s economic superpower in what was a sharply worded critique of the American political system.

Lowering the nation’s rating to one notch below AAA, the credit rating company said “political brinkmanship” in the debate over the debt had made the U.S. government’s ability to manage its finances “less stable, less effective and less predictable.” It said the bipartisan agreement reached this week to find at least $2.1 trillion in budget savings “fell short” of what was necessary to tame the nation’s debt over time and predicted that leaders would not be likely to achieve more savings in the future.

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 Marc Johnson worked for the House Oversight and Government Reform Committee until January. He is now unemployed.

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“It’s always possible the rating will come back, but we don’t think it’s coming back anytime soon,” said David Beers, head of S&P’s sovereign debt rating unit.

The decision came after a day of furious back-and-forth debate between the Obama administration and S&P. Government officials fought back hard, arguing that S&P’s analysis of the potential for political agreement was flawed and that its initial report, which was flagged by the Treasury earlier in the day, contained mathematical errors. The company had overstated the U.S. deficit over 10 years by $2 trillion.

“A judgment flawed by a $2 trillion error speaks for itself,” a Treasury spokesman said Friday.

The downgrade to AA+ will push the global financial markets into uncharted territory after a volatile week fueled by concerns over a worsening debt crisis in Europe and a faltering economy in the United States.

The AAA rating has made the U.S. Treasury bond one of the world’s safest investments — and has helped the nation borrow at extraordinarily cheap rates to finance its government operations, including two wars and an expensive social safety net for retirees.

Treasury bonds have also been a stalwart of stability amid the economic upheaval of the past few years. The nation has had a AAA rating for 70 years.

Analysts say that, over time, the downgrade could push up borrowing costs for the U.S. government, costing taxpayers tens of billions of dollars a year. It could also drive up interest rates for consumers and companies seeking mortgages, credit cards and business loans.

A downgrade could also have a cascading series of effects on states and localities, including nearly all of those in the Washington metro area. These governments could lose their AAA credit ratings as well, potentially raising the cost of borrowing for schools, roads and parks.

But the exact impact of the downgrade won’t be known until at least Sunday night, when Asian markets open, and perhaps not fully grasped for months. Analysts say the initial effect on the markets may be modest because they have been anticipating an S&P downgrade for weeks.

Federal officials are also examining the impact of a downgrade in large but esoteric financial markets where U.S. government bonds serve an extremely important function. They were generally confident that markets would hold up but were closely monitoring the situation. Regulators said that the downgrade would not affect how banking rules treat Treasury bonds — as risk-free assets.

The ratings action immediately fueled partisan wrangling Friday night. Allies to President Obama said it underscored his call for a “grand bargain” that would trim $4 trillion from the federal budget involving a mix of tax revenue and spending cuts.

Republicans criticized Obama’s handling of the economy.

“Standard & Poor’s rating downgrade is a deeply troubling indicator of our country’s decline under President Obama,” Republican presidential candidate Mitt Romney said.

S&P has angered government officials with aggressive warnings over the past few months of a potential downgrade. Those warnings, so far, have not worried government bond markets.

What’s more, the two other major credit rating companies, Moody’s Investors Service and Fitch Ratings, have said they would preserve the nation’s AAA rating for now.

S&P’s downgrade was as much a political critique as a financial conclusion. It is based on a view that American political leaders would be unable to come up with at least $4 trillion in savings, which is needed to bring the nation’s debt to a manageable level over the next decade.

The debt deal swung earlier this week proposed spending cuts in two phases. Democrats and Republicans agreed to the first round, worth nearly $1 trillion. But a Congressional committee must decide the remaining $1.2 trillion to $1.5 trillion — and S&P questioned whether that would ever happen.

S&P added that it expects that the upper income Bush-era tax cuts will continue, despite vows from Obama to end the breaks next year.

“The majority of Republicans in Congress continue to resist any measure that would raise revenues,” the firm said.

S&P’s downgrade served as an indictment of the gridlock that sent the nation to the edge of defaulting on its debt obligations. It is also striking in part because it reflects the tremendous power of a small group of financial analysts employed by a New York company — part of McGraw-Hill. In Europe, political leaders have taken aim at credit rating companies when they cut the ratings of governments struggling with heavy debt burdens.

S&P said the nation could suffer additional downgrades later on if the nation’s debt burden grows worse. “A new political consensus might [or might not] emerge after the 2012 election, but we believe that by then, the government debt burden will likely be higher,” the firm said.

The company said the United States’ financial position was diverging from that of other AAA countries, including Canada, France, Germany and Britain.

Countries with a AA+ rating include New Zealand and Belgium. Among those countries with a AA rating, one notch lower, are Bermuda, Spain and Qatar.

Staff writers Neil Irwin and Cezary Podkul contributed to this report.