Last week, Standard and Poor’s (S&P’s) downgraded the U.S.’s credit rating for the first time in history, moving the US from AAA to AA+. Although Moody’s and Fitch have not followed the S&P’s lead, both agencies indicated that their prime rating is contingent on future U.S. debt reduction.

The debt ceiling agreement reached two weeks ago included a pledge to cut spending by $2.4 trillion over the next 10 years; but the rating agencies have said that the reduction was insufficient, hinting that cuts of $4 trillion or more are necessary.

Although the downgrade could have significant long-term detrimental effects on the U.S. and world economies, it certainly isn’t the economic Armageddon that a U.S. default would have been. In other words, it could have been worse.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the U.S. debt crisis in Advisor’s Journal, see Debt Limit Deal Leaves Unfinished Business (CC 11-154), Democrats Call Debt Limit Unconstitutional (CC 11-134), & Debt Deal Talks Down to the Wire (CC 11-139).

The downgrade of U.S. debt could soon be more than just a threat. Taking note of the US’s large budget deficits and continually increasing government indebtedness, Standard & Poor’s (S&P) gives mixed signals about the state of reform, having changed its outlook on the U.S. long-term credit rating from “stable” to “negative.”

While talks about debt limit increases are still speculative, S&P believes there is a one-in-three probability it will downgrade the U.S. long-term debt rating within the next two years. Such a downgrade could cause an economic catastrophe by signaling that there is a heightened chance the US will be unable to pay its debts as they come due. A downgrade would likely tank the markets, the federal government would be forced to agree to higher interest payments to sell its debt, and consumers would face an even tougher lending environment.

For previous coverage of the U.S. budget in Advisor’s Journal, see Republican Ryan’s Budget Faces Bipartisan “Gang of Six” (CC 11-80).

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Why is this Topic Important to Wealth Managers? This blogticle is part of our casual Friday series that discusses topics relating to national, political, economic, global and other relevant issues. It is our intention to keep wealth managers well informed in areas affecting client planning.

The U.S. Department of the Treasury gladly welcomed S&Ps affirmation of its AAA rating and Moody’s view of recent fiscal announcements by both parties as a positive ‘turning point’ for the U.S. earlier this week.

The Treasury released the following statement earlier this week from Assistant Secretary for Financial Markets Mary Miller on the announcements by Standard and Poor’s and Moody’s:

“This morning, S&P affirmed the AAA rating of the U.S., but emphasized the importance of timely bipartisan cooperation and action on fiscal reform.  In addition, Moody’s commented today that ‘we view the changed parameters of the debate, with broadly similar goals as to government debt levels, as a turning point that is positive for the long-term fiscal position of the U.S. federal government.”

“As the President said last week, addressing the current fiscal situation is well within our capacity as a country.  He has initiated a bipartisan process that will allow us to make progress on a balanced approach to restoring fiscal responsibility.  The U.S. economy is strengthening as it emerges from the recent recession. Both political parties now agree that it is time to begin bringing down deficits as a share of GDP.”

“S&P assumes that the U.S. will enact ‘a comprehensive budgetary consolidation program – combined with meaningful steps toward implementation by 2013,’ but we believe S&P’s negative outlook underestimates the ability of America’s leaders to come together to address the difficult fiscal challenges facing the nation.”

Standard and Poor’s had the following to say regarding the characterization to a negative outlook for the U.S. Government: “Our negative outlook signals that we believe there is a likelihood of at least one-in-three of a downward rating adjustment within two years. Although we view the U.S. sovereign’s considerable strengths to largely outweigh material risks, primarily fiscal and external, we now believe these strengths might not be able to offset fully the continued credit impact from these weaknesses, during the coming two years, at the ‘AAA’ level.”

The question is can you blame the rating service? If you are to examine the 2012 Federal Budget it shows a projection over the next 10 years of a seven trillion dollar loss. The United States must take some serious strides to rectify the situation that has gotten out of control. A balanced budget is one critical area where lawmakers should focus and resolve our deficit and debt issues.

As S&P states, “The outlook reflects the possibility of a downgrade if political negotiations over when and how to address both medium- and long-term fiscal challenges persists beyond 2013.”  The rating agency stated that, “the lack of such an agreement by 2013, or a significant  further fiscal deterioration for any reason, could lead us to lower the rating.”

Next week’s blogticles will discuss planning concepts for wealth managers in 2011.

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