Fitch, a major credit ratings agency, recently downgraded the U.S. sovereign rating from AAA to AA+. While the markets reacted calmly to the decision, it is still significant. The U.S. has long been regarded as the safest economy in the world and has maintained its top-notch debt rating for decades. However, Fitch’s decision was influenced by how the federal government handled the recent debt crisis, similar to S&P’s downgrade in 2011. Fitch expressed concern over the country’s worsening financial situation and doubts about the government’s ability to address the growing debt burden due to deep political divisions, exemplified by the debt ceiling standoff. Treasury Secretary Janet Yellen strongly criticized Fitch’s decision, and the Dow Jones Industrial Average fell over 300 points in response.
Credit ratings are intended to indicate the safety of investing in a country’s or company’s debt. They function similarly to personal credit scores, determining the interest rates that need to be paid when selling bonds or securities. The ratings are assigned by three major companies: S&P Global Ratings, Moody’s, and Fitch Ratings. These ratings are crucial in bond markets worldwide, with companies needing multiple ratings from established agencies to sell debt. Ratings also influence investment decisions, particularly for developing countries, as some funds only invest in debt with certain ratings.
However, credit ratings agencies have faced criticism for their reliability. During the 2008 Global Financial Crisis, highly-rated subprime mortgage bonds failed, exposing weaknesses in the rating system. Although regulations were tightened after the crisis, the system of rating debt remains mostly unchanged. Credit ratings are subjective assessments, subject to differing opinions.
Losing its AAA rating in 2011 had a significant impact on the U.S., causing market slumps and drawing strong reactions from President Obama and Treasury Secretary Tim Geithner. While Fitch’s recent downgrade shares similar circumstances, the reaction has been milder. The reasons for the downgrade, such as deteriorating finances, increasing debt burden, and erosion of governance, are already widely known. The U.S. dollar remains a global reserve currency, and investors worldwide continue to hold trillions of U.S. government debt. Goldman Sachs predicts that there will be little immediate impact on financial markets as major Treasury security holders are unlikely to sell based solely on the ratings change.
However, there is a reputational hit to the U.S., which explains Secretary Yellen’s strong criticism of Fitch’s decision. Losing the AAA rating puts the U.S. further away from the small group of countries that maintain top ratings from all three major agencies. The issues identified by Fitch, including fiscal challenges like financing Social Security and Medicare, remain major risks for the U.S. Investors currently consider Treasuries the safest investments, but the country’s fiscal challenges and deep political divisions continue to grow. Failure to address these problems can have critical consequences.