08/08/2011 - US Debt
Downgrade by S&P - What does it mean to mortgage rates?
Late Friday, August 5th, 2011, Standard & Poor's debt rating service
cut the long-term U.S. Credit rating by one-notch to AA-Plus (AA+) on
concerns about the budget deficit and rising debt burden. On
Monday, August 8th, 2011, they also cut the senior debt issuer
ratings of Fannie Mae, Freddie Mac, the Federal Home Loan Bank
System, and Federal Farm Credit Banks to AA+.
"The downgrade reflects our opinion that the fiscal consolidation
plan that Congress and the Administration recently agreed to falls
short of what, in our view, would be necessary to stabilize the
government's medium-term debt dynamics," S&P said in a statement.
The outlook on the new U.S. credit rating is "negative," S&P said in
a statement, indicating another downgrade was possible in the next
12 to 18 months. S&P had warned that if the debt reduction
passed by Congress and signed into law did not reduce the deficit by
$4 Trillion that they may downgrade the U.S. Debt. The passed
legislation reduced the deficit by only $2.1 Trillion and S&P made
good on their warning.
The U.S. has had a AAA Credit Rating since 1941. Many folks
have asked us what this action may mean for mortgage rates.
First - it's important to note that only S&P downgraded
the U.S.'s Credit Rating. There are two other major rating services,
Moody's Investors Service's and Fitch Ratings. Moody's
confirmed the U.S. AAA Credit Rating last week. Fitch said
they would issue its opinion by the end of August.
And AA+ is not an awful rating. No one rated AA+ has
defaulted on their debt. In other words, don't expect the U.S. to go
bankrupt anytime soon. Other major countries rated AA+ are
China, Japan, and Spain. But the US is below Australia,
Canada, France, Germany, and the UK in terms of their ranking. (See this S&P link for
Warren Buffett even said, "US Debt should be rated Quadruple A"
as the country will not have any trouble paying off its long term
debt obligations. Investors agreed on Monday August 8th since they bought more US Debt driving bond prices up and
interest rates down. (see Bond Prices and Rates)
However, lending is about risk. If the person you are
lending too has a higher risk of not re-paying the debt, you most
likely will want to earn a higher interest rate to compensate for
that risk. It's why a person with a lower credit score has
If the investors in US Debt - private investors and other counties -
believe that we are truly a higher risk, that means rates will go
higher. And since mortgage rates are 'generally' based
on the 10 Year Bond Rate plus a margin - we may see mortgage rates go
up if investors believe S&P. 'Generally' because mortgage rates
are really based on Mortgage Backed Security bond rates, but the 10 Year Bond has proven to be a fair index. Why?
It's about risk -
the US Government is viewed as safer than Mortgage Backed Securities
- so their rates are lower. Again showing the point - rates
are about risk.
Of concern is the performance of the U.S. Economy and ability to
weather this downgrade. Right now the
Government is limited in what stimulus it can provide. Why?
Well they have provided an awful lot of stimulus lately, which drove
up the debt burden, which earned the downgrade of all our debt.
The impact on our stock market is yet to be seen, but since this
will cause pressure on our economy, we should see the stock market
drop (update late August 8, the market is down over 600 points in
one of the largest down days ever).
These may be a huge drag on the economy, and thus cause folks to
invest in the safety of bonds, driving rates down.
Is It Over Yet?
This is actually just the beginning. The Federal Reserve may
act to help the economy. It's hard to say how far the
financial markets will fall. And what investors will do about
investing in US Debt.
Stay tuned, it should be an interesting week.