The S&P Downgrade, One Year Later

S&P’s swipe at U.S. credit was consequence-free
Standard and Poor's Financial Services LLC company building in New York Photograph by Michael Nagle/Bloomberg

When Standard & Poor’s stripped the U.S. government of its top AAA credit rating last August, predictions of doom followed. Mitt Romney called it a “meltdown” and warned of high long-term interest rates and damage to foreign investors’ confidence in the U.S. Republican Representative Paul Ryan of Wisconsin, who chairs the House Budget Committee, said the cost of mortgages and car loans would rise. Mohamed El-Erian, chief executive officer of Pimco, the world’s largest bond fund, forecast erosion in the standing of the dollar and U.S. financial markets.

They were wrong. Almost a year later, mortgage rates have dropped to record lows, and the government’s borrowing costs have eased. Yields on 10-year Treasury notes—in effect, the interest rate the bond market charges the government on long-term credit—have plummeted from 2.56 percent just before the downgrade to 1.51 percent on July 17. The dollar is up 11 percent against an index of major currencies, and the Dow Jones industrial average has risen 12 percent. International investors’ enthusiasm for the U.S. has strengthened, with 46 percent of respondents in May’s Bloomberg Global Poll calling it the market with the most potential. Warren Buffett turned out to be prescient. “The U.S. is still triple-A,” he said in 2011 amid the uproar. “In fact, if there were a quadruple-A rating, I’d give the U.S. that.”

Even in a weak recovery—and despite the climbing deficit and national debt—the U.S. possesses unparalleled assets, including the size and resilience of its economy and the dollar’s standing as the world’s reserve currency. Few investors are willing to bet the U.S. government will fail to meet its debts, no matter how dysfunctional the politics become in Washington.

For now, anyway. That tentative faith may be tested if Republicans and Democrats stage another bitter, zero-sum fight over government spending like the one that led to the downgrade. Already the two sides are preparing for exactly that at the end of the year, when automatic spending cuts will kick in and the Bush-era tax cuts will expire unless the parties can reach a deal.

The vastly different way Democratic and Republican leaders characterize the nation’s economic health a year after the downgrade shows how difficult those negotiations will be. Optimists—including many Democrats, who have an incentive to portray the economy as improving under President Obama—stress the recovery of the U.S. auto industry, slight growth in manufacturing jobs, and progress, albeit slow, in lowering unemployment.

Pessimists—many of them Republicans, who have an incentive to portray the economy as worsening under Obama—argue that U.S. interest rates are being kept artificially low by temporary forces such as a flight of capital from Europe’s debt crisis and the Federal Reserve’s “Operation Twist” program to buy long-term debt. They warn that financial markets’ forbearance could end suddenly at any time if Congress and the president can’t get federal spending and the debt under control. “We are a safe haven for now,” Ryan says, cautioning that interest rates eventually will rise. “We just don’t know when.”

The lack of immediate consequences from the credit downgrade means members of Congress may be emboldened to once again play chicken with the debt in December, says Steve Bell, a former Republican staff director for the Senate Budget Committee now at the Bipartisan Policy Center in Washington. “It has persuaded a fair number of members of Congress that the effect of a downgrade is overstated, and it will not lead to some serious economic or financial problem.” William Daley, Obama’s former White House chief of staff, believes that’s a big problem. The markets may have taken the lowered credit rating in stride, but the public didn’t. “Consumer confidence dropped dramatically after the downgrade,” says Daley. “Do we really want to test that again?”


    The bottom line: A year after S&P took away the AAA credit rating of the U.S., almost every major economic indicator has improved.

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