Standard & Poor's strips US of AAA credit rating in historic move

• Damian Paletta
• From: The Wall Street Journal
• August 06, 2011 12:41PM

S&P has downgraded its rating on US Treasury debt. Source: AFP

A CORNERSTONE of the global financial system was shaken today when officials at ratings firm Standard & Poor's said US Treasury debt no longer deserved to be considered among the safest investments in the world.

S&P removed for the first time the triple-A rating the US has held for 70 years, saying the budget deal recently brokered in Washington didn't do enough to address the gloomy long-term picture for America's finances.

It downgraded US debt to AA+, a score that ranks below Liechtenstein and more than a dozen other countries, and on par with Belgium and New Zealand. S&P also put the new grade on "negative outlook", meaning the US has little chance of regaining the top rating in the near term.

The unprecedented move came after several hours of high-stakes drama.

It began in the morning, when word leaked that a downgrade was imminent and stocks tumbled. Around 1:30pm (New York time), S&P officials notified the Treasury Department they planned to downgrade US debt and presented the government with their findings.

 Treasury officials noticed a $US2 trillion error in S&P's math that delayed an announcement for several hours. S&P officials decided to move ahead anyway, and after 8pm (10am today AEST) they made their downgrade official.

S&P said "the downgrade reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilise the government's medium-term debt dynamics." It also blamed the weakened "effectiveness, stability, and predictability" of US policy making and political institutions at a time when challenges are mounting.

"A judgment flawed by a $2 trillion error speaks for itself," a Treasury representative said.

The downgrade will force traders and investors to reconsider what has been an elemental assumption of modern finance. Since July 14, when Standard & Poor's warned it could downgrade the credit rating, analysts have struggled to determine how such a move could affect the financial landscape, given how Treasurys permeate Wall Street and the economy.

It's possible the blow in the short run might be more psychological than practical.

Rival ratings firms Moody's Investors Service and Fitch Ratings have retained their top-notch ratings for US debt in recent days. And so far, US Treasury bonds have remained a safe haven for investors worried about the health of the US economy and the state of Europe's debt crisis.

The pre-announcement spat could further undermine the impact.

But the move by S&P could serve as a psychological haymaker for an American economic recovery that can't find much traction, and could do more damage to investors' increasing lack of faith in a political system struggling to reach consensus, even on everyday policy matters.

It could lead to the prompt debt downgrades of numerous companies and states, driving up their costs of borrowing. Policymakers are also anxious about any hidden icebergs the move could suddenly reveal.

A key concern will be whether the appetite for US debt might change among foreign investors, in particular China, the world's largest foreign holder of US Treasurys. In 1945, foreigners owned just 1 per cent of US Treasurys; today they own a record high 46 per cent, according to research from Bank of America Merrill Lynch.

Some investors believe Treasurys will remain a safe haven in a volatile world, even without a solid triple-A credit-rating. Others believe the US will be forced to pay higher interest rates, say about 0.5 percentage point higher, simply because they are seen as being slightly riskier than before. While only a slight gain, such a jump would increase the cost of a wide array of debt, from a home mortgage to the trillions carried by the US government itself.

Lessons from other countries, such as Canada and Australia, suggest it can take years for a country to win back its AAA rating. At the same time, the economic impact of past downgrades has tended to be larger when multiple firms move to rate a country's debt as riskier as opposed to a single firm acting unilaterally.