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Another downgrade of America’s credit rating might be coming

Is the United States still a safe bet? For decades, it has been. US Treasury securities represent the world’s largest bond market, underpinning retirement plans, corporate balance sheets, and investment accounts everywhere. In times of turbulence, investors flock to Treasuries because they’re viewed as a surefire way to protect your money.

But Standard & Poor’s downgraded the US credit rating by one notch the last time there was a serious debt-ceiling showdown, in 2011, when the government came within hours of defaulting on some of its obligations. Now that we’re in another debt-ceiling standoff, some analysts think further downgrades are on the way.

“Congress is playing chicken with the debt ceiling,” bank analyst R. Christopher Whalen of Whalen Global Advisors wrote in a May 10 analysis. “We think the amount of US debt already demands a credit downgrade. Just the increase in debt service costs is enough reason for ratings action.”

When S&P downgraded the US credit rating in 2011, for the first time ever, it cited both fiscal and political problems. President Obama signed a bill raising the federal borrowing limit on August 2 of that year, just hours before the Treasury would have run out of money, forcing it to default of some payments. S&P found the bill Obama signed unsatisfying. Three days later, it lowered its US credit rating from AAA to AA+, with a negative outlook, meaning further downgrades could occur.

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S&P said “the plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics ... The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed."

Twelve years later, the US fiscal position is objectively worse. The national debt has exploded from about $15 trillion in 2011 to more than $31 trillion today. As a percentage of GDP, total federal debt has ballooned from 65% in 2011 to 95%. The Congressional Budget Office forecasts that will rise to 132% 10 years from now. That’s around the same time Medicare and Social Security will start to run short of money.

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Interest payments on trillions of dollars of Treasury securities have been relatively low, because interest rates have been low, largely thanks to 15 years of monetary easing by the Federal Reserve. But the Fed has hiked rates by 5 percentage points during the last year, one of the fastest hiking cycles in history. That came just after Congress approved $6 trillion in COVID-relief programs in 2020 and 2021, most of that financed by borrowing. As a result of all that, US borrowing costs are soaring. In 2011, interest payments on all US debt totaled $425 billion. in 2022, interest payments hit $710 billion. In the first quarter of 2023, interest payments hit $929 billion on an annualized basis. The United States now spends as much on interest payments as it spends on defense.

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Other rating services did not lower their AAA ratings of US debt in 2011. But Moody’s and Fitch did change the US outlook from stable to negative that year, indicating a higher chance of a downgrade. Each agency later changed the US outlook back to stable. S&P also revised its outlook from negative to stable, though it never restored the gold-plated AAA rating.

In its most recent analysis of the US fiscal situation, on March 16, S&P affirmed the AA+ rating and said, “The stable outlook also assumes Congress will either raise or suspend the debt ceiling … We expect Congress will engage in brinkmanship, but ultimately pass debt ceiling legislation, as it has on over 80 prior instances.”

NEW YORK, NY - AUGUST 08:  People walk outside the New York Stock Exchange during afternoon trading on August 8, 2011 in New York City. The Dow plunged more than 500 points in afternoon trading after Standard and Poor's downgraded the U.S. credit rating.  (Photo by Mario Tama/Getty Images)
NEW YORK, NY - AUGUST 08: People walk outside the New York Stock Exchange during afternoon trading on August 8, 2011 in New York City. The Dow plunged more than 500 points in afternoon trading after Standard and Poor's downgraded the U.S. credit rating. (Photo by Mario Tama/Getty Images) (Mario Tama via Getty Images)

S&P said it could lower the US credit rating “if unexpected negative political developments weigh on the strength of American institutions.” A failure to raise the debt ceiling and some kind of default would probably check that box. S&P could also restore America’s AAA rating “if effective and proactive public policymaking results in improved fiscal performance that substantially reverses the recent deterioration in public finances.”

Fitch sounds leerier. In an April 23 memo, the agency said it would maintain its AAA rating as long as Congress resolved the debt-ceiling impasse with no damage to financial markets. If default becomes a serious risk, however, “the US’s rating would likely be placed on rating watch negative and further rating action could be considered.”

Fitch went further, blasting the whole debt-ceiling process, which many analysts think has outlived its usefulness. “The debt limit serves no purpose in guiding fiscal decisions,” the agency said. “Repeated near-default episodes brought on by debt limit debates could erode confidence that the US government’s repayment capacity is resilient to political dysfunction and may affect Fitch’s view of the sovereign credit profile.”

The S&P 500 stock index fell nearly 7% the first trading day after S&P’s 2011 downgrade, cementing a monthlong 15% drop in the market triggered by the whole debt-ceiling fiasco. If there's another downgrade, the novelty effect might not be as severe, since it would be the second-ever downgrade of US debt, rather than the first.

The aftermath of the 2011 downgrade also demonstrated that US Treasuries retained their status as a safe haven, allowing Washington to continue borrowing at the lowest possible rate. So the 2011 downgrade arguably didn’t turn out as damaging as feared. But it’s probably not wise to test our luck.

Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman

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