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Monday, August 8, 2011

S & P Downgrades US Credit Rating - Your Questions Answered

The United States lost its top-tier AAA credit rating from Standard & Poor's on Friday, a move that will affect the country's borrowing costs and investor opinion of US assets. As an investor, you might have many questions as an aftermath of the downgrade. This post aims at answering some (if not all) of them.

To Recap: What happened?

Standard & Poor's, one of the three major credit rating agencies that assign scores to debt issued by institutions, municipalities, and governments, said there is a heightened degree of risk in holding debt issued by the United States. So it lowered its rating from the AAA, the highest possible level, by one notch to AA+. It also said that the current outlook is negative.

Now, lets get on with the Questions!!!

1. Why did S&P lower the rating of United States of America?

The credit rating agency believes the outstanding debt of $14.3 trillion and projected deficits for coming years in the United States no longer warrant the top-tier rating that it had assigned to the United States since over 6 decades ago. It also said that the political environment does not build confidence that the United States can agree on how to lower the deficit in a meaningful way any time soon.

2. Does this mean that US debt is no longer safe?

Well, at the outset it might seem so.

NO. At AA+, the US is still considered to have a "strong" ability to meet its obligations. In fact, apart from the United States, only four countries now have the AAA rating. They are: Canada, Germany, France and the United Kingdom.

In addition, Treasuries have rallied this week, driving the yield on the benchmark 10-year note to 2.34 percent, its lowest level in about 10 months. This suggests people still view the US as a safe place to invest.

3. Wasn't a debt deal just signed by the Congress?

This is probably the most obvious question because, the news media has been going crazy over the new debt deal signed by the United States Congress.

Yes, but the savings from this are projected at $2.1 trillion. S&P has said that a larger level of savings is needed, at least $4 trillion either through spending reductions or tax increases are needed in order to start lowering US deficits in coming years.

4. What impact does the downgrade have and what will it cost?

Over time, a lower rating will cause investors who buy US government debt to demand a higher interest rate to hold that debt to reward them for the risk they are taking (If they consider AA+ risky). If that is the case, benchmark long-term interest rates will rise. Most major rates, including the debt of corporations, mortgages purchased by investors, and other types of loans, are priced in relation to the US Treasury benchmark. That means borrowing costs across a number of spectrums over time will rise, making loans and bonds more expensive. The more an individual or company is devoting to interest payments, the less they have for other activities.

The downgrade could add up to 0.7 of a percentage point to US Treasuries' yields, increasing funding costs for public debt by some $100 billion, according to SIFMA, a US securities industry trade group.

5. How much is the total debt of the United States?

Don't get astounded by the numbers...

Total US Debt: $14.1 Trillion
Debt Held by US Public: $9.49 Trillion
Debt held by Foreigners: $4.45 Trillion


6. Which foreign countries hold US debt?

The most recent data from the US Treasury shows that China, with $1.16 trillion in US Treasury securities, is the biggest holder of US debt.

The numbers for top US debt holders are:

China - $1.16 Trillion
Japan - $882 Billion
United Kingdom - $272 Billion
Brazil - $186 Billion
Taiwan - $155 Billion
Russia - $151 Billion
Hong Kong - $134 Billion
Switzerland - $107 Billion

Other Major Debt Holders:

Oil Exporting Countries: 211 Billion (Includes Saudi Arabia, Venezuela, Libya, Iran, Iraq, the United Arab Emirates, Bahrain, Kuwait, Oman, Qatar, Ecuador, Indonesia, Algeria, Gabon, and Nigeria)

Caribbean Banking Centers: 168 Billion (Includes Bahamas, Bermuda, Cayman Islands, Netherlands Antilles, British Virgin Islands and Panama)

Note: The numbers were picked up by internet search. The current US debt figures may or may not match the numbers mentioned above.

7. Now that S&P has downgraded the rating, is the US safe from other downgrades?

No. To begin with, Standard & Poor's has assigned a "negative" outlook to the US long-term credit rating. That means another downgrade is possible in the next 12 to 18 months if it does not see an improvement in debt reduction.

The other ratings agencies, Moody's and Fitch, currently still have a AAA rating on US debt, which they just affirmed. But both of those agencies have suggested the US could also be downgraded if projected government deficits are not reined in. Moody's currently has US debt on review for possible downgrade.

8. For how long has the United States maintained a AAA rating?

S&P has maintained a AAA rating on the US since 1941. Moody's has had an Aaa rating on the US since 1917 and Fitch has had AAA rating since 1994.

If you have any more questions on this topic, leave a comment and I will try to answer them.

2 comments:

  1. Hi anand...Will this rating raise gold prices if so for how long the gold price continues increasing....

    ReplyDelete
  2. Not directly... But, because of the current volatile circumstances in the stock markets around the globe, gold will be a preferred investment option because of the stability of gold prices. hence the price will continue to rise.

    Also, the price of gold may encounter a few corrections in future, but i dont see it going down in the next few years...

    ReplyDelete

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