The U.S. Default Risk May be Passing, but a Downgrade Could Still Lie Ahead

Photo Credit: Justin Lane/EPAIf the U.S. government’s credit rating is the backbone of the public financial system, then the negative credit watch issued by Fitch Ratings on Tuesday is akin to a bulging disc.

It may never cause a problem. But if it ruptures, the results could be painful. For the next few months, as the government approaches another debt limit and Fitch evaluates how the political system responds, the threat of a downgrade remains — and with it the risk of a broad rise in borrowing costs, not just for the federal government but also for countless state, city and local agencies whose credit ratings could be at risk as well.

The Fitch action highlights the central — and controversial — role played by the three large credit ratings agencies in the U.S. and global financial systems. The grades that Fitch, Moody’s and Standard & Poor’s use to rate the creditworthiness of institutions, governments and financial securities partly determine how much nations pay to raise money, how much a local sewer authority must charge its customers for debt service and whether a company can get the money it needs to build a factory.

The process is complex — combining hard data analysis, dense statistics and assessments of national politics and governance — and it sometimes has blunt results. The differences among the top ratings are not great, but a downgrade that pushes a country or company across the line from “investment grade” to “speculative” — a junk bond — can be catastrophic.

The ratings companies were criticized for the high grades given to the complex securities that helped spark the U.S. financial crisis. They were slammed in Europe as being too slow to downgrade Greece — the country kept investment-grade status through years of financial shenanigans — and too quick and vicious once they decided officials in Athens had lost credibility.

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