U.S. Loses AAA Rating: How Will it Affect Your Finances?

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In the eyes of at least one rating agency, the United States no longer deserves a perfect credit rating.

After the markets closed on Aug. 5, ratings agency Standard & Poor’s officially lowered the United States credit rating from AAA – the highest rating – to one notch below that, or AA+. Two other credit reporting agencies, Fitch and Moody’s, recently affirmed the AAA rating. Since these debt ratings were first established in the early 20th century, the U.S. has always been AAA, so this is an historic event.

In as few words as possible, here’s what’s happening and how it might affect you…

Why we were downgraded

In a word, debt. It’s no secret that the United States, along with many developed countries, is carrying massive debt. S&P believes we’re not moving effectively enough to address it. While Congress recently announced spending cuts in a last-minute deal to raise the debt ceiling, it’s too little too late.

In addition, the debt ceiling debate revealed to S&P, along with everybody else in the world, that partisan bickering in Congress could stand in the way of future progress on the debt. Here’s how they put it in their press release:

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 stabilize the government’s medium-term debt dynamics….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.

How will it affect your 401(k) or stock investments?

While a debt downgrade doesn’t directly affect stocks, it does reflect overall economic problems, so it’s certainly not good news.

Since the market has already tanked by more than 10 percent over the last two weeks and this downgrade was widely anticipated, the response when markets open on Monday may be muted. But as I wrote in last week’s Stock Sell-off: Is It Time to Panic?, this market is already trading on fear and uncertainty. Standard & Poor’s just threw a little more fuel on the fire.

Will interest rates rise?

People who have low credit scores pay more to borrow than those with higher scores. The same is true of governments. So a lower debt rating could translate into higher interest rates on government bonds. Since interest rates on government bonds are tied to many types of consumer loans, a higher interest rate on government debt could theoretically drive interest rates higher on everything from mortgages to student loans.

But interest rate increases on consumer loans will probably be small or even non-existent, for several reasons:

  1. The downgrade wasn’t that big. Going from AAA to AA+ from one credit agency is like one credit reporting agency lowering your credit score from 800 to 780: You’re still a top tier borrower.
  2. U.S. Treasuries are by far the largest and most efficient debt market in the world. For the world’s biggest investors (think China) it’s still the only game in town. In fact, rates on the 10-year treasury – the benchmark for mortgage rates – have recently fallen to historic lows as investors flee the stock market for the relative safety of bonds.
  3. Whether the rating is AAA or AA+, the full faith and credit of the United States still means something. In other words, the rating decrease reflects problems, but nobody is suggesting the United Sattes is in danger of defaulting on its debt.

What should you do?

If the downgrade puts the fear of God into those in Washington with the power to turn things around, it could ultimately prove to be a good thing. But while I’ve used the “glass-half-full” approach to describing potential negatives of this latest kick in the crotch to our nation’s economy, make no mistake: This isn’t good news. It could contribute to lower stock prices, higher interest rates, and a worse overall economy, especially in the short-term.

If you’re worried or will need your savings soon, I hope you’ve already taken some money out of the market. As I said in Stock Sell-off: Is It Time to Panic?, I haven’t sold any of the stocks in my online portfolio, a move that’s cost me close to 30 grand in market value in the last few weeks.

But it’s not like I didn’t see the writing on the wall. On June 10, I published a post called Investors Take Warning: Storm Clouds Gathering. So why didn’t I sell? Simple: Because sooner or later, the economy and the market will turn around, and I’m not smart enough to pick the bottom.

Stay tuned – if things change, I’ll write about it. In the meantime, if you want to delve into more possible effects of the rating downgrade, there’s plenty to read online, including CNN/Money’s S&P rating downgrade: FAQ.

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