United States federal government credit-rating downgrades

Several credit rating agencies around the world have downgraded their credit ratings of the U.S. federal government, including Standard & Poor's (S&P) which reduced the country's rating from AAA (outstanding) to AA+ (excellent) on August 5, 2011.

2011

The 2011 S&P downgrade was the first time the government was given a rating below AAA. S&P had announced a negative outlook on the AAA rating in April 2011. The downgrade to AA+ occurred four days after the 112th United States Congress voted to raise the debt ceiling of the federal government by means of the Budget Control Act of 2011 on August 2, 2011. Later, the US Government commenced an investigation into S&P's role in the rating of several mortgage backed securities which played a role in the 2008 financial crisis.^[1] In order to mend its relationship with the US government, S&P asked its then CEO to step down, a mere 18 days after the US was downgraded. S&P announced on August 23, 2011 that Deven Sharma would step down as a Chief of Standard & Poor's effective September 12, 2011, and would leave the company by end of the year.

The downgrade was criticized by the U.S. Treasury Department,^[2] both Democratic^[3][4] and Republican Party^[5][6] political figures, and many business people and economists.^{[7][8][9][10][11]}

Both Fitch Ratings and Moody's, designated like S&P as nationally recognized statistical rating organizations (NRSRO) by the U.S. Securities and Exchange Commission, retained the U.S.'s triple-A rating. Moody's, however, changed its outlook to negative on June 2, 2011 and Fitch changed its outlook to negative on November 28, 2011.^[12][13]

Background

CBO-Public Debt Under "Extended" and "Alternate" Scenarios

A credit rating is issued by a credit rating agency (CRA). A credit rating assigned to U.S. sovereign debt is an expression of how likely the assigning CRA thinks it is that the U.S. will pay back its debts. A credit rating assigned to U.S. sovereign debt also influences the interest rates the U.S. will have to pay on its debt; if its debtholders know the debt will be paid back, they do not have to price the chance of default into the interest rate. However, it should be noted that these ratings sometimes measure different things; for instance Moody's considers the expected value of the debt in the event of a default in addition to the probability of default.^[14] Some lenders also have contractual requirements only to hold debt above a certain credit rating.^[15]

The U.S. government enjoys the highest credit rating ("AAA"/"Aaa") from two of the Big Three CRAs. The U.S. enjoyed the "gold standard" of triple-A ratings from all three agencies (Fitch, Moody's and S&P) from the time of their recognition as standards by the SEC until the S&P downgrade in early August 2011.

Government agencies such as the Government Accountability Office, the Congressional Budget Office, the Office of Management and Budget and the U.S. Treasury Department have all reported that the federal government is facing a series of important financing challenges. In the short-run, tax revenues have declined significantly due to a severe recession and tax-policy choices, while expenditures have expanded for wars, unemployment insurance and other safety net spending.^[16][17] In the long-run, expenditures related to healthcare programs such as Medicare and Medicaid are growing considerably faster than the economy overall as the population matures.^[18][19]

Warnings of a downgrade

On April 18, 2011, U.S.-based rating agency S&P issued a "negative" outlook on the U.S.'s "AAA" (highest quality) sovereign-debt rating for the first time since the rating agency began in 1860, indicating there was a one-in-three chance of an outright reduction in the rating over the next two years. S&P considered the government budget deficit of more than 11 percent of gross domestic product (GDP), and net government debt rising to about 80 percent or more of GDP by 2013, to be high relative to other "AAA" countries.^[20] According to S&P, meaningful progress towards balancing the budget would be required to move the U.S. back to a "stable" outlook.^[15] The S&P press release stated: "We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium– and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would, in our view, render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns."^[20][21]

In June, Moody's followed suit, warning that if Congress did not quickly raise the debt ceiling above $14.3 trillion, the agency might reduce the debt rating. Moody's also commented on the political process, warning that the heightened polarization on both sides increased the risk of a default.^[12] On July 14, 2011, S&P issued a research update putting the U.S. debt on a 90-day CreditWatch.^[22]

On July 16, 2011, Egan-Jones Rating Company, a smaller CRA, cut its rating from AAA to AA+, the first NRSRO to do so.^[23]

S&P rationale for the downgrade

On August 5, 2011, representatives from S&P announced the company's decision to give its first-ever downgrade to U.S. sovereign debt, lowering the rating one notch to "AA+", with a negative outlook.^[24][25]

Governance and policy-making stability

S&P was direct in its criticism of the governance and policy-making process, which took the U.S. to the brink of default as part of the 2011 U.S. debt-ceiling crisis that same week:

• "More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011. Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon."^[25]
• "The political brinksmanship of recent months highlights what we see as 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. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability."^[25]

Revenues

S&P revised the revenue assumptions underlying one of their future debt-level projections:

• "Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act."^[25]

Improving the rating

The report specifically refused to take a position on the blend of policy choices necessary to improve or maintain the credit rating:

• "Standard & Poor's takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.'s finances on a sustainable footing.^[25]

Criticism

Both Democratic and Republican politicians criticized S&P's decision, as well as placing blame with the other party. Few blamed themselves despite bi-partisan Congressional responsibility for passing budget deficits from 2002 onward^[26] and significant deficits for the 2012–2021 periods in U.S. President Barack Obama's 2012 federal budget.^[27]

From the Obama administration

Almost immediately after S&P announced the downgrade, first reported after 8 p.m.^[28] on a Friday night, Obama administration officials began to publicly criticize S&P's decision.^[3]

From Republican political figures

Republican strategists blamed Democratic intransigence for the rating agency's decision, and many Republican presidential candidates blamed the actions of Obama:^[6]

• Tim Pawlenty: Pawlenty pinned the blame on Obama, calling him "inept when it comes to creating the conditions or job creation and economic growth". He called for a new direction and president.^[5]
• Jon Huntsman: Huntsman blamed “out-of-control spending and a lack of leadership in Washington" noting that the country needs "new leadership in Washington committed to fiscal responsibility, a balanced budget, and job-friendly policies".^[5]
• Mitt Romney: Romney blamed Obama's failed "leadership on the economy". He noted that "the only way things will get better is with new leadership in the White House."
• Rep. Michele Bachmann: Bachmann noted that Obama "has destroyed the credit rating of the United States through his failed economic policies and his inability to control government spending by raising the debt ceiling". She called on Obama to seek the resignation of U.S. Treasury Secretary Timothy Geithner and "to submit a plan with list of cuts to balance the budget this year, turn our economy around and put Americans back to work."^[6]

From Democratic political figures

Democratic politicians placed the blame for the downgrade on Republicans or elements of the Republican Party.

• Senator John Kerry referred to this as the "Tea Party downgrade," blaming Republican intransigence regarding revenues and disregard for the consequences of a default.^[4]

From commentators

In addition to the Obama administration's criticism, several liberal commentators, among them billionaire Warren Buffett and Nobel Memorial Prize winner Paul Krugman, also criticized the downgrade. Michael Moore demanded Obama "show some guts" and have the head of Standard & Poors arrested.^{[7][8][9][10][11]}

According to Mike Allen's Politico Playbook, "As a result of an error in constructing discretionary spending levels underlying the analysis, the deficit was $2 trillion higher over 10 years than the Congressional Budget Office would estimate. Treasury flagged the discrepancy to S&P, which admitted a mistake."^[6]

Commentators pointed out that a downgrade might result in an increase in interest rates required to finance U.S. debt, potentially raising interest costs.^[29]

An August 7, 2011, editorial by Bloomberg mentioned that several other countries downplayed the downgrade.^[30]

Market consequences

Global stock markets declined on August 8, 2011, following the announcement. All three major U.S. stock indexes declined between five and seven percent in one day. However, U.S. treasury bonds, which had been the subject of the downgrade, actually rose in price and the dollar gained in value against the Euro and the British pound, indicating a general flight to safe assets amid concerns about a European debt crisis.^[31]

However, based on historical information from Bloomberg, the cost to insure U.S. debts against default has risen from an average of around 25 basis points in 2007 to a range from 55 to 75 basis points in 2011. A higher cost of insurance is typically associated with increased risk of default.

2012

Although none of the Big Three took any downgrade action in 2012, Egan-Jones downgraded twice further. After its initial rating cut on July 16, 2011 from AAA to AA+, Egan-Jones cut its rating a second time on April 5, 2012 from AA+ to AA "because of the lack of any tangible progress on addressing the problems and the continued rise in debt to GDP."^[32] On September 14, 2012, Egan-Jones cut its rating a third time from AA to AA-, the lowest of what is considered "high grade", as a reaction to QE3.^[33]

2013

On October 15, 2013 the credit agency Fitch warned that it may cut the U.S. credit rating, citing the political brinkmanship over raising the federal debt ceiling.^[34]

On October 17, 2013 Dagong Global Credit Rating downgraded the United States from A to A-, and maintained a negative outlook on the country's credit.^[35]

2014

Fitch Ratings on March 21, 2014 upgraded its outlook for the U.S. AAA credit rating, removing the nation from a downgrade watch after politicians put off another debt limit battle until next year. The company, one of three major credit rating firms, changed the outlook for the rating to stable from a negative watch put in place in October.^[36]

Potential consequences to credit rating agencies

Two weeks after the August, 2011 S&P downgrade, SEC and Department of Justice announced that S&P was under investigation. Columnist Bob Sullivan of NBC News asked if "the ratings downgrade from Standard & Poor’s [could] be viewed as a shot back at a government that's been taking plenty of shots at the ratings industry lately."^[37] And two years later in 2013, S&P "blasted a $5 billion fraud lawsuit by the U.S. government as retaliation for its 2011 decision to strip the country of its AAA credit rating."^[38]

Two weeks after the second downgrade by Egan-Jones in April 2012 to AA, the SEC voted to bring administrative action against that firm regarding years-old activity. Mr. Egan said at the time, "We are not going to be intimidated by anybody from issuing timely, accurate ratings."^[39] After Egan-Jones agreed to a settlement in 2013, the SEC director Robert Khuzami said in a press release, "EJR and Egan's misrepresentation of the firm's actual experience rating issuers of asset-backed and government securities is a serious violation that undercuts the integrity of the SEC's NRSRO [Nationally Recognized Statistical Rating Organization] registration process."^[40] In response, a Fox Business Network editor raised the question of "government retaliation" and an Egan-Jones spokesman issued a non-apology apology stating that the "SEC settlement lets us focus on what we do best—producing the most accurate and independent ratings in the business."^[41]

See also

• United States debt-ceiling crisis of 2011
• United States debt-ceiling crisis of 2013
• National debt of the United States

References

External links

Official S&P reports

• Research Update: United States of America 'AAA/A-1+' Rating Affirmed; Outlook Revised To Negative, April 18, 2011
• Fiscal Challenges Weighing On The 'AAA' Sovereign Credit Rating On The Government Of The United States, April 18, 2011
• Credit FAQ: A Closer Look At The Revision Of The Outlook On The U.S. Government Rating, April 18, 2011
• Criteria | Governments | Sovereigns: Sovereign Government Rating Methodology And Assumptions, June 30, 2011
• Research Update: United States of America 'AAA/A-1+' Ratings Placed On CreditWatch Negative On Rising Risk Of Policy Stalemate, July 14, 2011
• Special Report: U.S. Negative CreditWatch Placement And The Knock-On Effects, July 18, 2011
• The Implications Of The U.S. Debt Ceiling Standoff For Global Financial Institutions, July 21, 2011
• The U.S. Debt Ceiling Standoff Could Reverberate Around The Globe—With Or Without A Deal, July 22, 2011
• Research Update: United States of America Long-Term Rating Lowered To 'AA+' On Political Risks And Rising Debt Burden; Outlook Negative August 5, 2011
• "Press Release: Standard & Poor's Clarifies Assumption Used On Discretionary Spending Growth", August 6, 2011
• Ratings On Select GREs And FDIC- And NCUA-Guaranteed Debt Lowered After Sovereign Downgrade, August 8, 2011
• Ratings On The U.S. Central Securities Depository And Three Clearinghouses Lowered Following U.S. Sovereign Downgrade, August 8, 2011

Official S&P video

• "Standard & Poor's Lowers The U.S. Sovereign Credit Rating To 'AA+' On Debt And Budget Concerns; Outlook Negative". August 7, 2011, video with David T. Beers, Standard & Poor's Global Head of Sovereign Ratings, and John B. Chambers, Chairman of the Sovereign Ratings Committee