U.S. downgrade raises anxiety, if not interest rates

WASHINGTON - (AP) - The real danger from the downgrade of U.S.government debt by Standard & Poor's isn't higher interest rates.It's the hit to the nation's fragile economic psyche and rattledfinancial markets.

S&P's decision to strip the U.S. of its sterling AAA creditrating for the first time and move it down one notch, to AA+, dealsa blow to the confidence of consumers and businesses at a dangeroustime, economists say.

The agency is "striking at the heart of what makes the globaleconomy tick," says Chris Rupkey, chief financial economists forthe Bank of Tokyo-Mitsubishi UFJ. "It isn't just dollars andcents."

One economist, Paul Dales of Capital Economics, worried Saturdaythat the downgrade could trigger another financial crisis thatsends Western economies back into a recession.

The timing could hardly be worse for the U.S. The economy added117,000 jobs in July, more than expected. But other economicindicators, including manufacturing, consumer spending and overallgrowth, are getting weaker.

And the markets just came through their most harrowing two weekssince the financial crisis of 2008. The Dow lost about 10 percentof its value on fears of a new recession and Europe's spiralingfinancial problems.

In normal times, in another country, a downgrade in a country'ssovereign debt rating probably would force its government to payhigher interest rates to convince investors to keep buying itsdebt.

If that happened, it would drive up the rates that consumers payon mortgages and auto loans, which are often tied to thegovernment's interest rate.

But the United States is a special case. Treasury debt isconsidered the safest investment in the world - even after thedowngrade. Investors don't doubt the U.S. government's ability torepay the $9.8 trillion it owes.

They also know they can easily buy and sell Treasury bills,notes and bonds. Rupkey calls Treasurys the "strongest, deepest,most liquid" market in the world.

"Anytime there's a problem anywhere on the planet, investorscome to the safety of the U.S., and they don't go anywhere else,"says Mark Zandi, chief economist at Moody's Analytics.

Despite worries about the U.S. government's huge debts andrumors of an impending downgrade from S&P, the yield on 10-yearTreasury bonds was still a low 2.56 percent Friday.

That's because investors, worried about the weak U.S. economyand debt troubles in Europe, saw American bonds as a safer place toput their cash than, say, stocks.

"Where else are you going to put your money?" says Joe Libin,a Salt Lake City mortgage banker. "We're growing anemically. We'vegot a debt problem. But at least we're bobbing along. We'rebest-looking of the ugly kids at the prom."

U.S. banking regulators also moved quickly to reinforce thesecurity of Treasury debt after S&P announced the downgrade Fridaynight. Regulators said they would continue to view Treasurys as azero-risk investment and would not force banks to hold more capitalagainst their Treasury investments.

There had been fears that some financial institutions withobligations to hold only top-rated investments might suddenly sellU.S. government debt on the open market - forcing the price downand the yield up, and leading to higher interest rates.

The vote of confidence by the bank regulators lessens the risk.In addition, the other top rating agencies - Moody's and FitchRatings - have maintained top ratings on U.S. government debt.

The S&P downgrade also doesn't apply to short-term U.S.Treasurys - bonds that mature in a year or less - only to long-termgovernment debt. That means the downgrade shouldn't rattle moneymarket funds that invest in short-term Treasuries.

Mark Vitner, senior economist at Wells Fargo Securities, agreesthat the S&P downgrade is unlikely to drive up interest rates rightaway. But he says that's partly because the economy is so weak thatborrowers aren't competing for money and driving rates higher.

In three to five years, he says, loan demand will be higher.When that happens, a U.S. Treasury with a dinged credit rating willbe vying with private borrowers for loans and investments, andrates will likely rise.

"The greater consequences are going to be in the intermediateand long-term," he says. "If it didn't mean anything, S&Pwouldn't have downgraded us."

The Obama administration made its displeasure known quicklyafter the downgrade was announced. The Treasury Department said S&Phad acted on an analysis that had a $2 trillion error.

On Saturday, the administration appeared to soften its tone.White House press secretary Jay Carney, without referring directlyto the downgrade, said President Barack Obama believes Washington"must do better" tackling the deficit.

Already, there were signs that the downgrade itself would becomea volatile political issue.

Senate Majority Leader Harry Reid, D-Nev., said the S&P decisionshowed that Democrats' preferred solution to long-term debt, a mixof tax increases on the wealthy and budget cuts, was the rightanswer.

House Speaker John Boehner, R-Ohio, said he hoped Democratswould learn they can't "tinker around the edges" of the U.S. debtproblem. And Republican presidential candidates for 2012 laid blameon Obama.

S&P had called for $4 trillion in U.S. deficit reduction. Thedeal cut by Congress early last week called for only about $2trillion over the next decade. S&P said it wasn't enough to addressAmerica's debt problem.

The rating agency also said the decision reflected its loss ofconfidence in the U.S. political system. Republicans and Democratsdidn't reach a deal on debt reduction until hours before thefederal government's borrowing limit was to expire, which wouldhave trigged a U.S. default on its debt or massive, immediategovernment cuts.

Economists say the downgrade, the first since the U.S. receivedthe top rating in 1917, will rattle consumers and businessesalready worried about the weak economy and the U.S. politicalsystem's inability to handle the country's problems.

Some fear the Dow Jones industrials, which fell 512 points onThursday alone because of fears about the economy and Europe, willplummet Monday when investors get to vent their anxiety.

An early sign of what's to come may emerge Sunday U.S. time,when Asian markets open.

America's reputation has already taken a hit abroad. China, thelargest foreign holder of U.S. debt, on Saturday demanded that theUnited States tighten its belt and overcome its "addiction todebt" in the wake of the S&P downgrade.

The state-run Xinhua News Agency declared: "The U.S. governmenthas to come to terms with the painful fact that the good old dayswhen it could just borrow its way out of messes of its own makingare finally gone."

"It's going to be tougher for the U.S. to attract capital,"Vitner says. "If you're a business and you're deciding where toinvest your earnings and investors' capital, you're looking aroundthe world. The U.S. suddenly looks riskier."

S&P downgrades U.S. credit rating from AAAStocks end mixed after day of wild swings

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