Economy
4:05 am
Sun August 7, 2011

American Pride Takes A Hit With S&P's Downgrade

For generations, the United States and its debt — sold in the form of U.S. Treasuries — have been synonymous with safety. Now, though, the nation's sterling credit is tarnished. The ratings agency Standard & Poor's has downgraded the U.S. from AAA to AA-plus, one notch down. The downgrade has raised big questions about what this will mean for investors and for the nation as a whole.

A few years ago, it was unthinkable that the United States would have its credit downgraded, but a lot of unthinkable things have happened since then — like the global financial collapse, the European debt crisis and a fight over the debt ceiling that took the nation to the brink of default.

"What matters is that someone dared to downgrade, and it's a shock to American pride," says Tyler Cowan, professor of economics at George Mason University. "It's a way of saying our government isn't working right now."

In justifying the downgrade, S&P focused on political issues, saying it wasn't sure leaders in Washington were willing to take on the difficult task of truly addressing the nation's longer-term debt issues. Cowan says this downgrade could be an opportunity.

"What you need are people looking at themselves long and hard in the mirror and saying, 'I was partly responsible for this. How can I change?' And if we don't do that that, I think it's just going to get worse," he says.

What's not clear is whether this "shock to American pride" will also come with a financial shock when the markets open on Monday morning.

"The initial reaction might be quite negative," says Mark Zandi, chief economist at Moody's Analytics, "but by the end of the day — certainly by the end of the week — I don't think this is going to have a negative impact."

Zandi says a lot of investors saw this downgrade coming. He says it's also important to note the other two major credit ratings agencies, his parent company, Moody's, and Fitch, are sticking with their AAA ratings so far.

"This is an opinion of one analyst committee at a ratings agency. This doesn't change anything," Zandi says.

He says the opinions of bond investors are what really matter. As of last Friday, even as rumors of a downgrade swirled, they were still buying lots and lots of U.S. Treasuries.

"If there's any trouble anywhere on the planet, they come to the U.S. Treasury as a safe haven," Zandi says.

The largest investors aren't making their decisions based on what S&P says. They do their own risk analysis.

The downgrade does create some complications, though. Many large institutional investors have guidelines that say their money can only go into super-safe AAA investments. Mohamed El-Erian is CEO of PIMCO, the big investment firm that manages money for U.S. pension funds and overseas investors.

As he put it, the U.S. used to be the only clean shirt in the drawer. Now it's the cleanest of the dirty shirts — not perfect, but the best option. Still, he says there are other ripples to consider, perhaps most significantly, the psychological effect of being a nation that's no longer totally AAA.

"We are at a fragile time for confidence...and this loss of AAA, which was unthinkable, will erode confidence further," El-Erian says.

That erosion could slow economic growth even further — the real danger of being an AA-plus nation.

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