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US debt rating downgraded for first time in history

August 5, 2011 12:00:00 AM PDT
Credit-rating agency Standard & Poor's downgraded the United States debt rating from "AAA" to "AA-plus" Friday, the first downgrade in national history.

The rating represents one "notch" on the credit-rating scale.

The deficit-reduction plan passed by Congress Tuesday was not enough to stabilize the U.S. debt situation, according to the S&P.

Standard & Poor's released a statement Friday: "The outlook on the long-term rating is negative. We could lower the long-term rating to 'AA' within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.

"We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade."

Five easy to understand effects:

  1. The interest rates the government pays to finance the growing national debt will almost certainly rise as a result of the downgrade. That increases the amount of money Uncle Sam has to spend each year on "debt service." General market discussions have turned on an increase in rates that would up the annual tally by about $10 in the short-term and go up to $75 billion in additional costs in the coming years.
  2. The interest rates YOU and YOUR EMPLOYER pay will go up. Basic credit facilities -- like mortgages, student loans and credit cards -- are all at least loosely tied to the rates the government pays. A half a percent increase in mortgage rates could increase the total cost of the average traditional mortgage by $19K (on a $172K home). Businesses would have to spend more money to finance expansions. Costs for borrowed money goes up, effectively raising the price of anything you're not paying for with cash.
  3. Needless to say, increasing costs for consumers and businesses tends to slow their economic activity. Some estimates put a downgrade like this as likely to shave 1 percent off GDP. This slowing certainly increases the risks that the U.S. will have a second dip into recession. It also means less tax revenue, so the potential for additional debt increases.
  4. As the economy slows, expect the stock market to react -- after all investors buy shares to get a piece of growing profits. Slowing economy means profits grow less rapidly or go down. The relative value of a share of anything will go down. Some experts predict a downgrade could force stocks to sell-off by 6-10 percent in short order. That's another 1,100 points on the Dow.
  5. A slow down in economic activity also means less demand for workers. The non-partisan group Third Way has published estimates that a simple 0.5-percent increase in interest rates could erase more than 640,000 jobs.

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