Despite debt deal, US could still face a downgrade in its credit rating

Raising the debt ceiling may not be enough to keep rating firms from downgrading US credit from its coveted 'triple-A' rating. What would a downgrade mean for the US economy?

By Mark Trumbull, Staff writer / August 2, 2011

A view of the US Capitol dome and US Senate (r.) in Washington before the Senate voted on a deal to raise the debt ceiling, Tuesday, August 2.

Jonathan Ernst/Reuters

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This week's bipartisan deal in Washington averts a worst-case outcome for financial markets, but it doesn't remove the risk that the US Treasury will see its credit rating bumped downward soon.

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That's because the debt deal agreed by Congress and the White House – passed by Senate vote Tuesday after House approval the day before – offers only a partial fix to the nation's fiscal problems.

A credit downgrade from a rating firm like Standard & Poor's or Moody's would mean the US loses its pristine "triple-A" credit score. In effect, credit analysts would be saying that the risk of a default by the Treasury is a bit higher than it was last year.

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What the debt accord announced on Sunday achieves: Congress's self-imposed cap on federal borrowing will rise enough to allow the government to pay its bills through the 2012 election. And it shows that Democrats and Republicans have been able to agree on sizable spending cuts, to reduce future federal deficits by about $2.1 trillion over the next 10 years.

What remains unsolved: Future deficits would still be high enough to push public debt higher as a share of the overall economy. The bipartisan negotiations also failed to make headway on the question of reforming entitlement programs, the key driver of future projected deficits. And a standoff between the parties on tax policy – where the elimination of some tax breaks could potentially help fund deficit reduction – left that issue for future debate.

In all, many finance experts say deficits would need to come down by about twice as much – $4 trillion over 10 years – in order to stabilize public debt and prevent it from harming economic growth.

The upshot: It's still possible that, even amid relief that politicians reached a deal, the US will see its credit rating marked down a notch.

The move would be more than just an embarrassment. It could impose some tangible costs to the economy, such as marginally higher interest rates throughout the economy. At the same time, the word "downgrade" should not be confused with "default."

A downgrade by Standard & Poor's from AAA to AA simply means that a rating firm believes US fiscal policy could use some improvement.