Everyone is talking about it: something that seemed impossible certainly became reality yesterday. However, let’s pause for a moment because this is not the end of the world. Undoubtedly, it’s neither the first nor the last time that such an event will occur.
Let’s delve into the reasons why the rating agency Fitch downgraded the United States from AAA to AA+ and explain what that means for investors and the general public.
This week, the rating agency Fitch caused a big surprise. Fitch lowered the USA’s rating from the highest evaluation to “AA+” (previously “AAA”). The agency justified this by expressing concerns about the budget deficit in the coming years and ongoing discussions about the debt ceiling. Back in 2011, S&P had downgraded the USA and withdrawn the top rating. The only major rating agency that still assigns the USA the top rating of “AAA” is Moody’s.
Now that you have some background information, and have also heard about another rating agency that remains strongly positive about America’s rating, let’s provide a brief summary of rating agencies and their pivotal role in the financial world. A rating agency is a company that evaluates the financial strength of businesses and governmental entities, especially their capacity to meet principal and interest payments on their debts. The rating given to specific debt reflects the agency’s level of confidence that the borrower will fulfill their debt obligations as agreed.
Standard & Poor’s, Moody’s, and Fitch are the three leading credit rating agencies. The “big three,” as some people call them, wield considerable power in determining the creditworthiness of corporations, state governments, and even entire nations. The big three are independent from one another and, most importantly, from the entities they rate. However, the business model of these agencies has drawn criticism. Ultimately, they are paid by bond issuers.
Bond issuers pay these agencies for the service of providing ratings, and no one wants to pay for a low rating. Due to these and other limitations, ratings should not be the sole factor investors depend on when evaluating the risk of a particular bond investment. This brings me to my point: while these agencies and ratings are crucial in assessing governments and financial institutions, they should not be the only metric that investors consider.
In the case of the United States being downgraded from AAA to AA+, it means that their creditworthiness has shifted from ‘excellent’ to ‘slightly less excellent.’ However, this in no way implies that the United States will default on its long-term or short-term debt. Therefore, it’s important to consider the broader context before making any hasty decisions.
What leads to a rating downgrade? Find out here in our newest Article.