An FYI: What does S&P do, and what does a drop in the credit rating mean?
August 7, 2011 10:36pm CST
This is a simple basic explanation, without going into too much detail. What is S&P, and what do they do? S&P (Standard and Poors™) is a rating agency. They serve people who invest money. Let us say that I have $1,000, and I want to buy some stocks in a company. Which company should I choose? There are many ways to choose, but one help is a rating agency like S&P. If I look up Apple computer company, at the S&P, I'll find they have a AAA Rating. That is the best. Now that doesn't mean there is no risk, but I can trust that as far as S&P knows, Apple computer is a safe investment. They are not broke, and won't crash tomorrow. Similarly, if I look up NCR Corp, they recently spent $1.1 Billion, and don't have any money. Thus they have a high risk, and likewise, S&P lowered their rating to BB-, which is junk status. So I likely wouldn't buy their stock. Bonds are the same thing, and thus government bonds have ratings too. In order for rating agencies to keep their position in the market, to keep people coming to them for ratings, their ratings must be honest and valid. Thus S&P has lowered the US government rating to AA+, which is one notch below AAA. So what does lowering the US Gov credit rating mean? Well not much. Remember S&P is one of three or four rating agencies, and they are the only one that has lowered the Gov's rating. Yes, there might be a wave in the stock market, because the stock market is driven on emotions. A tiny thing can cause massive waves in the stock market, but there isn't much to worry about there. What effect will this have on the government borrowing money? Well again, not much. The rating drop is a sign to people buying bonds, that possibly US Government bonds are not as safe as they once were (which is true). As such, the US government might have to slightly increase the interest it pays on bonds, in order to get people to buy them. As a result, the cost of borrowing may go up. I would wager not by much though. It's kind of like having a 600 credit score instead of a 750. You can still get a loan, but you likely will be paying 5% to 6% interest, instead of 4% like most people. What about in the future? In the future if we do not change course, our rating will continue to slide until we can't get people to buy our bonds anymore. When that happens, the government will be unable to borrow money to keep paying for these programs. This will be a national government shut down. We'll end up like Greece, with massive austerity measures, because we simply can't borrow enough to pay for everything. But this doomsday situation will only happen if we don't stop doing what we're doing. If we stop, we can change this. In the short term, this is just a warning sign. There is no impending doom right now.