Standard & Poor's Downgrades US Credit Rating From AAA to AA+

Downgrade could imperil U.S. economy by driving up rates on services.

Aug. 5, 2011 — -- For the first time ever, the United States lost its perfect credit rating as Standard & Poor's reduced its U.S. long-term debt assessment from AAA to AA+ with a negative outlook.

In announcing the move late Friday, the ratings agency said a deal this week to reduce the nation's debt did not go far enough and exposed paralyzing political dysfunction.

The downgrade could cost the government and ordinary consumers billions of dollars by jacking up interest rates the U.S. must pay on its $14.4 trillion debt and a host of rates consumers pay for items such as mortgages, car loans and credit cards.

The move by S&P follows decisions by two other major ratings agencies, Moody's Investor Service and Fitch Ratings, to maintain the United States' AAA rating, though Moody's assigned a negative outlook.

Moody's stood by its rating Friday, though Fitch said it "expects to conclude its scheduled review of the U.S. sovereign rating by the end of August in light of the Aug. 2 [deficit reduction] agreement."

S&P on US Government: 'Less Stable, Less Effective and Less Predictable'

Standard & Poor's gave strong emphasis to that agreement in announcing its decision.

"The downgrade," S&P said, "reflects our opinion that the fiscal consolidation 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."

In particular, Standard & Poor's added, it grew more pessimistic about U.S. debt because of the bitter political fight over raising the debt ceiling.

"The political brinksmanship of recent months," the company said, "highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed."

The agency pointed to political reluctance to make cuts to entitlement programs such as Medicare and Social Security, and Republicans' refusal even to consider increasing revenues by, for instance, ending the Bush tax cuts.

"Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place," the company said. "We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the [debt ceiling deal]."

Last month, Standard & Poor's warned that the U.S. risked a downgrade to AA status if Congress did not lift the debt ceiling and reduce the total debt by $4 trillion over the next decade. The eventual deal called for barely half as much deficit reduction.

S&P: 'We Could Lower the Long-Term Rating to AA'

Though today's downgrade was to AA+, S&P said it was possible the U.S. credit rating could drop even lower.

"The outlook on the long-term rating is negative," the company's announcement said. "We could lower the long-term rating to 'AA' within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case."

Ironically, it's possible the downgrade itself might lead to a weaker economy. That would mean less revenue. And it likely will mean higher government interest costs, which would mean more expenditures. Both would seem to make a further downgrade more likely.

The federal government had been expecting and preparing for Standard & Poor's to downgrade the rating of U.S. debt, government officials told ABC News before the reduction was formally announced, but they were fighting the possibility.

Treasury Rips S&P 'Judgment Flawed by a $2 Trillion Error'

The downgrade puts heat not only on the government. The uncertainty surrounding the U.S.'s formerly perfect AAA rating has thrust the three major ratings agencies into the spotlight, raising questions about the significance and boundaries of their credit assessments.

Robert Reich, former labor secretary in the Clinton administration, earlier called the prospect of an S&P downgrade "the height of hubris" in light of the Aug. 2 debt deal.

Hours before the downgrade, a government official said S&P's analysis was "based on flawed math and assumptions" and that "S&P has acknowledged its numbers are wrong" during communications with the Obama administration.

Sources said S&P ultimately corrected its error -- neglecting to subtract about $2 trillion, relative to the March 2011 Congressional Budget Office baseline -- and issued its downgrade statement reflecting debt-to-GDP projections that are far more conservative and in line with CBO's expectations.

Nevertheless, a Treasury Department spokesperson told reporters, "A judgment flawed by a $2 trillion error speaks for itself."

The nation's banking regulators also did not appear to follow the lead of Standard & Poor's. After the downgrade the regulators -- Federal Reserve, the FDIC, the NCUA and the OCC -- issued guidance to their regulated banks, effectively telling them that despite the downgrade, they are not going to force them to change the way the U.S. debt-related holdings are treated on their books.

"For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change," the regulators said. "The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board's Regulation W, will also be unaffected."

In simple terms, the banking regulators seemed to be saying that while S&P might believe Treasuries are riskier, the banking regulators don't, and therefore the banks don't have to either.

GOP Contenders Slam President Obama

Nevertheless, GOP presidential candidates were quick to slam the White House.

Mitt Romney called the downgrade "a deeply troubling indicator of our country's decline under President Obama."

Former Obama ambassador to China Jon Huntsman ripped his former boss for "presiding over the first downgrade of the United States credit rating in our history."

Newt Gingrich tweeted, "The Obama disaster continues."

Tim Pawlenty called Obama economically "inept."

Herman Cain called it "a sad day for America," and derided Obama as "a weak leader."

Rep. Michelle Bachman, R-Minn., pushed for Treasury Secretary Tim Geithner's resignation and urged Obama "to submit a plan with a list of cuts to balance the budget this year."

Rep. Ron Paul, R-Texas, directed his fire at "the Washington establishment," but he, too, proposed "serious steps" toward an immediate balanced budget.

Critics of such rapid cuts voice concern over what they would mean to Medicare and Medicaid spending and their possible destructive impact on an already fragile economy.

Friday, the Labor Department announced that payrolls expanded by 117,000 jobs in July as unemployment fell to 9.1 percent, a bit of good news in what has been a dismal series of economic reports this summer. However, though the 117,000 number exceeded expectations, it was still considered a weak job-creation figure.

On Wednesday, payroll company ADP reported that the private sector added 114,000 jobs in July, far short of what's needed to get the job market moving again.

On Tuesday, the Commerce Department reported consumer spending fell 0.2 percent in June.

And July 29, the U.S. government said the economy expanded at a disappointing 1.3 percent annual rate in the second quarter after growing just barely at 0.4 percent during the first quarter.

Other Credit Agencies Still Rate U.S. Debt AAA

S&P was the last of the major ratings agencies to comment about U.S. credit rating after the Senate passed an agreement Tuesday to raise the debt ceiling and avoid a default on U.S. debt, following passage in the House on Monday evening.

After the bill passed in the Senate, Moody's affirmed its AAA rating on U.S. sovereign debt but lowered its outlook to "negative."

"The initial increase of the debt limit by $900 billion and the commitment to raise it by a further $1.2-1.5 trillion by year end have virtually eliminated the risk of such a default, prompting the confirmation of the rating at AAA," Moody's said in its report on Tuesday.

Moody's assigned a negative outlook, explaining it could downgrade the U.S. on four conditions. Those factors included the following: if fiscal discipline weakens in the coming year, if further "fiscal consolidation" does not take place in 2013, if the economic outlook "deteriorates significantly," or if there is an appreciable rise in the government's spending "over and above what is currently expected."

Earlier on Tuesday, Fitch also affirmed its AAA rating for U.S. debt over the short-term, but warned of more tough choices coming soon.

"While the agreement is clearly a step in the right direction, the United States, as in much of Europe, must also confront tough choices on tax and spending against a weak economic back drop if the budget deficit and government debt is to be cut to safer levels over the medium term," Fitch said in a statement.

'The Most Significant Downgrade in the History of Rating Agencies?'

But Standard & Poor's disagreed, leading to a credit rating reduction that analysts dreaded.

"If they downgrade the U.S. Treasury, that will be the most significant downgrade in the history of rating agencies," Jim Kessler of Third Way, a non-partisan economic think tank in Washington, D.C., told ABC News last week.

Analysts predicted a downgrade might mean:

a 6 percent drop in the stock market, meaning the average 401(k) of $140,000 would lose $9,000.

mortgage rates rising at least a half point. That's a $19,000 hike on the average $172,000 home loan.

the overall economy getting hit with 1 percent drop in GNP, translating into 640,000 lost jobs.

And that's just the immediate damage.

"I would compare it to a marriage where one spouse cheats on the other," Kessler said last week. "The marriage may survive, but it will never be the same again. And if there is a downgrade on U.S. treasuries, our economy will survive but it will never be the same again, as well."

ABC News' Jim Avila contributed to this report.