On August 5, 2011, the rating agency Standard & Poor's downgraded U.S. debt from AAA ("triple-A")to its second-highest rating, AA+. S&P also downgraded the credit ratings of Fannie Mae, Freddie Mac and other agencies whose bonds are linked to long-term U.S. debt. This represented the first downgrade of the United States since S&P began issuing ratings in 1941. Standard & Poor’s was the only major rating agency to issue a downgrade; Fitch Ratings and Moody’s Investor Service both maintained their ratings.
Investors use credit ratings to measure the risk of investing in the debt of a particular issuer. While institutions do their own research to determine an issuer’s creditworthiness, the rating is nonetheless an important benchmark.
S&P cited two factors behind its decision: first, that the budget agreement of 2011 was insufficient to reduce the sharply rising U.S. debt; and second, that the combative tone of the budget debate showed that “America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.”
The move was accompanied by intense criticism out of Washington. The U.S. Treasury took S&P to task for what they saw as a $2.1 trillion dollar error in the agency’s accounting, as well as S&P’s decision to go ahead with the downgrade even after being informed of the discrepancy. In his blog on the Treasury Department website, Acting Assistant Secretary for Economic Policy John Bellows stated: “Independent of this error, there is no justifiable rationale for downgrading the debt of the United States… The magnitude of this mistake – and the haste with which S&P changed its principal rationale for action when presented with this error – raise fundamental questions about the credibility and integrity of S&P’s ratings action.” Standard & Poor’s acknowledged the mistake on August 6, 2011, the day after the downgrade, but nonetheless maintained its lower rating.
The White House also attacked the decision. In an article published on August 6, the New York Times reported: “Gene Sperling, the director of the White House national economic council, called the difference, totaling over $2 trillion, ‘breathtaking’ and said that ‘the amateurism it displayed’ suggested “an institution starting with a conclusion and shaping any arguments to fit it.’”
At the same time, other participants noted that move underscored the need for the United States to tighten its belt. Most notably, China’s state-run Xinhua news agency referred to S&P’s downgrade as “an overdue bill that America has to pay for its own debt addiction and the short-sighted political wrangling in Washington.” China certainly has an interest: it's the largest holder of U.S. debt.
Although it led to intense debate, the S&P downgrade did not indicate that the government could no longer be relied upon to make its principal and interest payments as scheduled. An actual default would wreak havoc in the financial markets and cause the country's interest burden to soar, since the U.S. government would need to offer investors higher rates to compensate them for the higher risk. These events, in turn, would virtually guarantee a sudden economic contraction in the United States - an outcome that the country's political leaders would seek to avoid at all costs, for obvious reasons.
Instead, the downgrade simply indicated that the country's enormous level of debt relative to the size of its economy meant that the outlook was not as bright as it was when the United States' debt burden was much lower. As a result, U.S. Treasuries remain one of the safest investments in the world despite S&P’s downgrade.