What The Debt Rating Agencies S&P, Fitch, and Moody Mean To You

If you have been following the headlines, you no doubt know that Standard and Poor has downgraded the United States’ credit rating from a perfect AAA to a respectable, but not spectacular AA+.  The new rating reflects decreased confidence in the ability of the United States to pay its debt obligations.  The United States has held its AAA rating since 1917 and this is the first time it has been lowered.

Standard and Poor’s is an independent financial services company that conducts analysis and provides intelligence on international stock markets.  The data it collects is analyzed, and presented in the form of credit ratings, indices, and investment research.  Investors then use this information to make decisions.  The two other noteworthy rating services, Fitch and Moody’s, left their AAA rating for U.S. debt unchanged, but indicated reconsideration at a later date.    

Your Stocks

History suggests that when a country’s credit rating is downgraded, the stock market takes a tumble.  The immediate effect has been significant--the market will take a nosedive.  However, when Canada lost its AAA rating in 1993, the country’s stocks climbed slightly over 15% in the following year.  The Tokyo stock market gained 25% after Moody’s downgraded Japan in November 1998.

Interest Rates Will Rise

The credit rating downgrade indicates that there is more risk in lending to the United States government.  Therefore, the US will now have to take on higher interest rates to receive loans.  In other words, the government now has to spend more to borrow the same amount of money. 

Many interest rates on loans to everyday Americans are linked to the yield on U.S. Treasury bills.  This means you will have to pay more to acquire loans for houses, cars, and college education.  

Higher Taxes

If the government has to pay more to borrow the same amount of money, that extra amount needs to have a source--the American taxpayers.  The U.S. cannot continue to borrow with no tax increases.  Where exactly will the tax hikes be?  This will be a Congressional subject for debate.

Your Cash Is Safe (Probably)

FDIC-insured bank accounts and money market funds are safe and will not be affected by this particular downgrade.  However, the FDIC (Federal Deposit Insurance Commission) still relies on the United States government to pay account holders whose banks went belly-up.  Further downgrades could bring this function of the FDIC into question.  Short-term money market funds will not experience a dramatic shift because the downgrade has been limited to long-term U.S. bonds.