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SPEA policy brief examines downgrading of U.S. credit

Aug. 5, 2011, when Standard & Poor's downgraded the rating for U.S. debt, was a sad day in the nation's fiscal history, Craig Johnson of the Indiana University School of Public and Environmental Affairs writes in a recent policy brief from SPEA.

But the rating change shouldn't have come as a surprise, he writes: S&P gave plenty of warning that it was likely to act if the government didn't take steps to control its debt. Johnson also argues that S&P may have strayed from its proper role by trying to guide policy, not just evaluate creditworthiness.

The article, "The Downgrading of the United States of America: Does It Certify the Fiscal Decline of America?" is the November 2011 issue of SPEA Insights, a series of policy briefs by SPEA faculty members. Johnson is an associate professor in the School of Public and Environmental Affairs, specializing in capital markets and public budgeting and finance.

"While the media circus that was the debt ceiling negotiations of the summer of 2011 was unseemly, reputable financial experts are expected to have the vision to see beyond the immediate frenzy into the longer-term substance of fiscal affairs," he writes. "I believe S&P got caught up in the emotional frenzy and lost their perspective. By trying to influence fiscal policy events, they lost their way and became part of the process rather than simply being an unbiased, third-party evaluator of credit quality for investors."

In the policy brief, Johnson explains credit ratings and recounts the events that led to the downgrading of U.S. debt as Congress deadlocked over a measure to raise the federal debt ceiling. He addresses the projected trends in U.S. indebtedness under the 2011 Budget Control Act and comments on the roles played by Congress, the Obama administration and the ratings agencies.

He writes that the S&P downgrade of U.S. debt from AAA to AA+ was "both foreseen and avoidable," because S&P gave the government public and private notice that a ratings change was likely. In April 2011, it revised the outlook for U.S. debt from stable to negative, warning of the risk that policymakers could not agree to control long-term debt. In July, it placed the U.S. on Credit-Watch Negative.

S&P even specified what it would take to avoid a downgrade: an agreement between Congress and the administration to cut deficits by $4 trillion over the next decade. At that point, Johnson writes, S&P "crossed the line of an impartial, external evaluator of credit quality and insinuated itself into the federal government's internal fiscal policy decision-making process."

Johnson writes that, since studying the interactions between New York political officials and credit agencies in the mid-1980s, he has observed that Standard & Poor's puts more weight on the politics of creditworthiness than the other agencies. "Political ineptitude on public display in response to real and fundamental fiscal problems is not taken lightly by S&P," he says.

But while Standard & Poor's downgraded the U.S. credit, the other "Big Three" agencies, Moody's Investors Service and Fitch Ratings, didn't. Moody's confirmed its Aaa rating but assigned the U.S. a negative credit outlook. Fitch kept its rating at AAA with a stable outlook.

"I believe Moody's got it right," Johnson writes. He said Congress and the administration must demonstrate over the next few years that they can maintain fiscal discipline in order to avoid having U.S. credit downgraded by all three agencies, which would certify "the fiscal decline of America."