Washington: Already battered by a week-long turmoil, financial markets across the world faced more uncertainty ahead as Standard and Poor’s (S&P), one of the leading rating agencies on Friday removed the US government from its list of risk-free borrowers for the first time ever.
The agency said it was cutting its rating of long-term US federal debt to AA+, one notch below the top grade of AAA. It described the decision as a judgment about the nation’s leaders, writing that “the gulf between the political parties” had reduced its confidence in the government’s ability to manage its finances.
“The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge,” the company said in a statement.
The agency warned that the government still needed to make progress in paying its debts to avoid further downgrades. The downgrading is a result of the Obama administration and the US Congress’s failure to arrive at a deal earlier this week to come up with an effective package to reduce the country’s growing public debt through expenditure cuts and additional revenue mobilisation.
It reflects a lack of confidence about the ability of the world’s largest economy to stage a stable recovery in the near future – a situation not very encouraging for other economies world-wide.
The Obama administration reacted with indignation, noting that the agency had made a significant mathematical mistake in a document that it provided to the Treasury Department on Friday, overstating the federal debt by about $2 trillion. “A judgment flawed by a $2 trillion error speaks for itself,” a Treasury spokeswoman said.
The downgrade could lead investors to demand higher interest rates from the federal government and other borrowers, raising costs for governments, businesses and home buyers. But many analysts say the impact could be modest, in part because the other ratings agencies, Moody’s and Fitch, have decided not to downgrade the government at this time.
The announcement came after markets closed for the weekend, but there was no evidence of any immediate disruption. A spokesman for the Federal Reserve said the decision would not affect the ability of banks to borrow money by pledging government debt as collateral, a statement that could set the tone for the reaction of the broader market.
S&P had prepared investors for the downgrade announcement with a series of warnings earlier this year that it would act if Congress did not agree to increase the government’s borrowing limit and adopt a long-term plan for reducing its debts by at least $4 trillion over the next decade. Earlier this week, President Obama signed into law a Congressional compromise that raised the debt ceiling but reduced the debt by at least $2.1 trillion.
Earlier on Friday, the agency notified the Treasury that it planned to issue a downgrade after the markets closed, and sent the department a copy of the announcement. A Treasury staff member noticed the $2 trillion mistake within the hour, said an official. The Treasury called the agency and explained the problem. About an hour later, the company conceded the problem but did not indicate how it planned to proceed, the official said.
Hours later, however, S&P issued a revised release with new numbers but the same downgrade conclusion. Yields rose before the Congressional deal on fears of default and a possible downgrade. But after a deal was struck, yields sank as money poured into treasuries as a safe haven from sharply falling stocks and the turmoil of the European debt markets. On Friday, the price of treasuries fell sharply in heavy selling, and yields rose, reversing the moves of recent sessions.
The US government makes about $250 billion in interest payments a year, so even a small increase in the rates demanded by investors in US debt could add tens of billions of dollars to those payments.