The Credit Rating Downgrade That Wasn't: Consumers Should Remain Vigilant

Late last summer, Standard & Poor’s stripped the U.S. of its AAA credit rating in the aftermath of DC’s failed debt-ceiling negotiation. S&P said the failure of Democrats and Republicans to agree on budget cuts made the U.S. less creditworthy, citing “the effectiveness, stability, and predictability of American policy-making and political institutions have weakened.” This generated a fair amount of hand-wringing and speculation about what the consequences might be.

The Cause for Concern

The prevailing concern was that borrowing costs for the U.S. government would rise, based on the belief that an agency downgrade would translate into investors that buy bonds requiring higher rates of return for the now-increased risk. If the government pays more, then the consumer pays more since the interest rate the United States pays on short term borrowing is determined by the market for Treasury bills (bonds.) Many consumer loans, such as credit cards and mortgages are linked to the yield on Treasuries and therefore would also rise. It has been speculated that the increase in borrowing costs would translate into higher default rates, putting more stress on the financial sector and housing market.

Nearly five months have passed since the agency’s downgrade, and so far the above concerns have yet to be realized. Borrowing costs have actually improved, that is, gone down for both the U.S. Government and the consumer. And while it is worth mentioning that five months is a very narrow window to assess the impact of the credit rating downgrade, this post gives explanation on why, so far, things have only improved for Uncle Sam, bond investors and consumers. 

Relative Strength

The S&P ratings downgrade is, without question a negative development, yet U.S. treasury bonds are still assessed relative to the remainder of the world-wide market. As the outlook for the American economy strengthens, the outlook for other parts of the world is deteriorating. Economists have raised their forecasts for growth in U.S. Gross Domestic Product (GDP) next year to above 2 percent, while forecasts in the Euro zone have been cut to 1 percent. U.S. consumer confidence, as measured by the Thomson Reuters/University of Michigan preliminary index, rose to a six-month high in December. These hopeful signs are in somewhat of a stark contrast as Europe struggles to save its currency union and the developed world weakens. 

These factors, and others offer proof that a downgrade in, and of itself does not change the equation in government borrowing. While the economy continues at a slog and jobs are still an issue, relative to other economic regions the U.S. is still
in better shape. Real pain for Uncle Sam would not be felt unless the two other ratings agencies, Moody’s and Fitch, were to follow S&P’s move with a downgrade of their own. Recently, both firms have said they still believe that the United States deserves the highest credit rating. However, they did warn that could change, and that the country must reduce its debt and stabilize its economy.

Be Vigilant

From the standpoint of a consumer, there is reason for caution. One need look no further than the U.S. Credit Crisis of 2008-09 to find a warning that when everything seems well, there is still reason to be skeptical. Just because a credit downgrade has not had an immediate impact, does not mean that it won’t later—especially when the systemic problems identified by the ratings agencies have yet to be addressed. 

Consumers should be prudent in their use of revolving-debt, which usually carry variable interest rates. You should know what your exposure is to periodic rate changes if you have a first mortgage adjustable rate mortgage (ARM) or a home equity line of credit. They might be affordable today, but a change of 1% in rate on a $300,000 loan would increase the payment by nearly $200.00.

Talk to your bank, credit union or mortgage lender to learn more about your options. If you have fixed rate financing for your home or car, then it is likely that those are in good shape.