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America's Credit Downgraded: What You Need to Know

Morgan Housel
August 5, 2011

Rumors were swirling all day, and then it finally hit: Standard & Poor's downgraded the nation's credit rating this evening, the first time the U.S. Treasury has lost its pristine AAA rating since ratings began nearly a century ago.

S&P now rates the United States at AA+. The rating agency didn't beat around the bush when describing why it made the cuts:

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. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

No big surprises here. The rating agencies have had the nation's credit rating on notice for months, warning Washington that without getting its fiscal house in order, and keeping political cage matches away from serious economic issues, a downgrade loomed. The debt-ceiling deal struck earlier this week failed on the former, and made the latter go prime-time. So here we are.

What's it mean for markets? No one can say for sure. Some sort of visceral fear-laden response on Monday seems likely. If there is a big selloff, it's not just about investors panicking. It's about investors expecting that other investors will be panicking and trying to preempt them. D