Make us your home page

Today’s top headlines delivered to you daily.

(View our Privacy Policy)

What's the trouble with a lower bond rating?

S&P announced that it downgraded the U.S. debt from AAA to AA+ Friday night. Commentators are split as to whether this would have major negative consequences for both the U.S. and world economy, or whether it would be basically meaningless.

Why it might matter

If the U.S. debt gets downgraded, many other debt instruments will likely get downgraded as well. When Moody's put U.S. debt on review for downgrade during the debt ceiling standoff, if also put on notice 7,000 other bonds, worth a total of $130 billion, that rely directly on revenue from federal government payments, such as certain kinds of municipal bonds. Bonds that are indirectly dependent on the federal government, such as those issued by hospitals that receive Medicare payments, or defense firms reliant on Pentagon contracts, could get downgraded as well. In addition, many everyday interest rates — such as those for mortgages, car loans and credit cards — are pegged to U.S. Treasuries, meaning that if a downgrade forces up interest rates on U.S. debt (which is likely, but will depend on how the markets react) interest rates for those will shoot up as well. This would raise the cost of borrowing across the system, depressing the economy.

It would also lead to widespread uncertainty. As the Post's Ezra Klein has written, "The cornerstone of the global financial economy is the idea that Treasuries are risk-free." A downgrade would mean Treasuries are no longer risk-free, and thus shake up the whole system. The last time AAA debt lost its luster in such a dramatic fashion was 2008, when AAA-rated subprime securities were discovered not to be sound. The result was the current financial crisis.

Additionally, many institutional investors — such as pension or money market funds — are required to hold a certain amount of AAA debt, meaning that some might be forced to sell off U.S. debt in the event of a downgrade. Given that money market funds hold about $338 billion in U.S. debt, or almost half of short-term holdings, this would be an enormous sell-off, which would raise interest rates still higher and greatly amplify the economic damage incurred due to a downgrade.

Why it might not

Ratings are generally used as a proxy to determine the financial health of entities that investors may not know much about. But everyone knows about the health of the U.S. government, and now that the debt ceiling debate has passed no one thinks it is going to default any time soon. Thus, investors that might normally be inclined to not buy or keep AA rated debt could make an exception for U.S. Treasuries. Indeed, some pension and money market funds have considered loosening their rules around debt ratings to allow higher holdings of U.S. debt in the event of a downgrade. Further, AA is still a very high rating. AA firms have statistically identical performance to AAA ones, according to the Fitch rating agency. Just this past January, S&P downgraded Japan's debt from AA- to AA, and markets more or less didn't care.

Bottom line

The United States has never been in this situation before, so it is hard to see who is correct. When, in April, S&P declared the long-term outlook on U.S. debt to be negative, it was the first time it had done so since Pearl Harbor. Moody's has rated U.S. debt as AAA since the firm started conducting ratings in 1917. There is simply no modern precedent for a U.S. downgrade.

The Triple A Club:

risk-free borrowers

These 18 countries have the highest credit rating, AAA, from Standard & Poor's. The triple-A rating enables nations to borrow funds at a low cost, because their governments are considered stable and their bonds safe. Moody's and Fitch are the other two agencies that grade the credit of companies and governments.









Hong Kong

Isle of Man










Source: Standard & Poor's; CNN

What's the trouble with a lower bond rating? 08/05/11 [Last modified: Friday, August 5, 2011 11:11pm]
Photo reprints | Article reprints

© 2017 Tampa Bay Times


Join the discussion: Click to view comments, add yours

  1. Early morning fire breaks out at Clearwater Beach motel


    Clearwater Fire and Rescue is at the scene of an early morning fire that broke out at a motel on Clearwater Beach.

  2. Florida education news: Free speech, Schools of Hope, student voices and more


    FREE SPEECH: The University of Florida reluctantly hosts white nationalist activist Richard Spencer for a rally officials are encouraging students to ignore. Campus president Kent Fuchs, who tried to prevent the activity from taking place, Troopers prepare for Richard Spencer's speech at the University of Florida. Gov. Rick Scott has declared a State of Emergency for Alachua County ahead of the event.

  3. How old is too old to go trick-or-treating on Halloween?

    Human Interest

    Brandi Eatman guesses the boy was at least 15 years old.

     Costume accessories at House of Make Believe at 1055 N Hercules Ave. in Clearwater. [CHERIE DIEZ | Times]
  4. Report: West Pasco channel dredges could cost up to $13.5 million

    Local Government

    NEW PORT RICHEY — The cost of dredging a dozen coastal canals serving seven west Pasco communities could reach nearly $13.5 million, according to a consultant's report.

    WILL VRAGOVIC   |   Times
 A consultant recommends that Pasco County consider a dozen canal dredging projects in west Pasco's coastal communities at a cost that could reach nearly $13.5 million. [WILL VRAGOVIC, Times 2011]
  5. Records show Hernando Beach fire chiefs defrauded taxpayers of thousands

    Local Government

    BROOKSVILLE — The three former chiefs of the defunct Hernando Beach Volunteer Fire Department, arrested in September, are collectively accused of defrauding the taxpayers of Hernando Beach, Aripeka and Forest Glenn of tens of thousands of dollars.

    David Freda, a former Hernando Beach fire chief, has been charged with organized fraud. He recently was fired as Brooksville’s fire chief.