On August 5, Standard & Poor's downgraded United States debt for the first time in the country's history, causing immediate worry about the country's financial health around the world.
But what does S&P's action really mean? Should you, the average citizen, be concerned? GefilteBacon gives you the answers.
First, what did Standard & Poor actually do?
They downgraded the rating of U.S. debt instruments, like Treasury bills, from their highest rating, AAA, to the second highest, AA+. They also indicated that the rating could be downgraded further in coming months.
Why did they do this?
They stated that it was a combination of concerns over the federal government's debt and a sense that the recently passed debt ceiling plan did not reduce annual deficits enough.
So what does it mean for me?
It could mean that some investment funds that are required to hold only AAA-rated bonds will have to sell U.S. paper, making Treasuries less valuable on international markets, and it could ultimately lead to higher interest rates. Of course, this could cause the economy to slide back into recession if lending is curtailed because of higher rates, businesses become even less willing to hire, and consumer demand for loan-based items like homes and automobiles drops even further.
Would this impact the rest of the world?
U.S. Treasuries are still the most heavily held debt instrument in the world, and the world relies quite heavily on the American economy, which is still the world's largest. Therefore, any large shift in the U.S. economy or the value of U.S. debt could rock an already fragile global economy. Furthermore, a perception that the United States' long-term fiscal outlook is negative could very well harm our global image and reduce our leverage on major international issues, from terrorism to nuclear proliferation.
And all that could happen because of Standard & Poor's decision? They must be very powerful.
Indeed they are.
Which agency of the government do they report to?
They are a private company.
A private company?
They are a division of McGraw-Hill.
McGraw-Hill? Isn't that the company that makes textbooks?
They also own some local T.V. stations.
Where did they come from?
They were founded in the late 19th Century by Henry Varnum Poor, a Maine timber magnate.
So a guy who made money cutting down trees in Maine built the company that now has the power to throw the entire global economy into chaos?
It's the American dream.
But at least they have a stellar record in rating financial institutions and activities, right?
Absolutely.
Absolutely?
Well, not absolutely. They did give consistently high ratings to Wall Street's exotic financial schemes, like subprime mortgage-backed securities, giving pension funds, mutual funds and city governments the confidence to invest in them, which of course then caused them to go belly up when the whole Ponzi scheme fell apart in 2008.
If Standard & Poor's and the other credit rating agencies had done due diligence on these schemes and rated them less favorably, is it likely that they would not have become so ubiquitous and the subsequent economic crisis might not have been as bad?
One could argue that.
And if the economic crisis hadn't been so bad, then the federal debt would be lower, too, because there'd be more tax revenue and less need for safety net programs, right?
Perhaps.
Therefore, Standard & Poor's is, in some part, responsible for the federal debt situation they are basing their downgrade on.
We don't like to assign blame.
Well, at least Standard & Poor's suffered financially from their negligence in the 2000s, right?
They made tens of millions of dollars rating these investments.
But certainly prior to that they never gave a top rating to any other dubious entity, right?
Right. Mostly right.
What do you mean, "mostly right"?
They did give top ratings to some companies that, possibly, and we stress
possibly, were not as financially sound as they claimed.
Such as?
Bear Sterns. AIG. Lehman Brothers.
Are you kidding me?
And Enron.
Enron? They gave Enron a top rating? And now they are the arbiter of the global economy?
Everyone makes mistakes.
Does that mean they might have made a mistake this time, on the U.S. debt?
It's unlikely. Or likely.
Which is it, likely or unlikely?
They did make a small mistake on their analysis of U.S. debt last week.
How big a mistake?
Just an accounting error.
How much?
Two trillion dollars.
Two trillion dollars is an "accounting mistake"?
For a firm that said Enron was healthy, sure.
So who decided that Standard & Poor's should have such sway over our government and economy?
The Securities and Exchange Commission, which has designated them and a few other credit rating agencies as a "nationally recognized statistical rating organization."
And how do they decide who gets to be a "nationally recognized statistical rating organization"?
Congress passed a law in 2006 that set those criteria for the SEC.
2006. Isn't that around the same time Congress was gutting the SEC's budget, despite the fact that Wall Street was spiralling out of control with risky subprime mortgages? And after they blew it on Enron?
We're not that good with dates.
So let us get this straight. Our economy - in fact, the world's economy - is now in the hands of a for-profit company founded by a timber magnate that has not only given a top rating to every fraudulent company in the last decade, but actually exacerbated the current financial crisis it now criticizes the government for not fixing fast enough, all because it has been bestowed credibility by the very same legislators and regulators who allowed the financial crisis to grow out of control in the first place.
If you wanted to put a "spin" on it.
We are starting to have chest pains. Could you call 911 for us?
Due to budget cuts, your city has reduced emergency services to six hours a day. This is not one of those hours.
So what am I supposed to do now?
We suggest you look elewhere for reliable medical advice.
How am I supposed to find reliable medical advice when I'm having a heart attack??
Try this.
