5 consequences of a U.S. credit downgrade
Businesses, investors, and local governments are bracing for the possibility that one of the big three ratings agencies will downgrade America's sterling AAA credit rating, as the Aug. 2 deadline for raising the debt ceiling approaches with no solution in sight. Even if House Speaker John Boehner manages to get his debt plan through Congress, a downgrade remains likely, because the ratings agencies — Standard & Poor's, Moody's, and Fitch — are looking for deeper spending cuts and a longer-term debt ceiling hike than Boehner has proposed. How would a downgrade affect Americans? Here are five of the biggest potential repercussions:
1. Mortgage and credit card interest rates spike
With a lower credit rating, the federal government would have to offer higher interest rates to get people to buy its bonds. If that happens, says Jim Tankersley at National Journal, "interest rates figure to soar — and likely, mortgage rates with them." The problem will be even worse if the Aug. 2 deadline hits and the government has to prioritize its bills. All this amounts to less money in the pockets of people looking to buy a house or make a mortgage payment. "Forget a recovery in housing," says IHS Global Insight economist Nariman Behravesh, as quoted at The Huffington Post.
2. Stock and bond markets tank
Financial markets are in for a rough ride until the debt crisis is resolved. Investors are "fixated on Washington's debt-ceiling impasse, and the Dow's five-day skid has brought the index down 484 points" already, say Walter Hamilton, Nathaniel Popper, and Tom Petruno at the Los Angeles Times. Not only is the prospect of an unprecedented downgrade, and even a government default, stoking government uncertainty, but "higher interest rates could eat into corporate profits, which are the lifeblood of stock values." If a downgrade comes, try not to look at your retirement account for a while.
3. State and local governments take a hit
The federal government's woes will spread to local governments that depend heavily on money from Washington. Moody's has already warned 162 local governments in 31 states, 14 housing finance programs, and one university that it is reviewing their AAA ratings. If local governments get downgraded, it will instantly become more expensive for them to finance construction projects, such as roads and government buildings, by issuing municipal bonds. "Our market is definitely on pause," says Tim Pynchon, municipal bond portfolio manager at Pioneer Investments, as quoted in The Wall Sreet Journal. "Everyone's attention has turned to the immediate deadline looming."
4. Student loan costs rise
If yields on government securities rise, "student loan rates could rise as well," says Mark Kantrowitz, publisher of the FinAid and Fastweb Web sites, as quoted at The New York Times. And that certainly won't help the federal government, either. It sells Treasuries to finance them, and profits on the interest from the loans. "If the government’s cost of borrowing rose, the government's profit would decrease." The bad news for students is that they might be in for a shock no matter what, as any debt-ceiling and deficit reduction plan is likely to cut education spending and, possibly, student lending.
5. Government pension funds falter
Investment managers and local politicians have been struggling to repair pension funds battered by the Great Recession. The loss of Washington's top credit rating, "which Treasury debt has held for nearly a century," would instantly reverse much of that progress by upending markets and reducing the values of their stocks and other holdings. "This added issue just creates a risk that we don't need," says Thomas DiNapoli, New York state comptroller, as quoted at The Huffington Post. "It's been a strong recovery for most funds — and certainly for ours — but we're all very aware that it's a tenuous and fragile recovery."