Your Anti-Panic Guide to the U.S. Downgrade & More

Stock Market - DemystifiedWhat is a “downgrade” exactly? It’s similar to when your credit score takes a hit; lenders question whether you’re going to repay your debts.

Similarly, the credit rating of the U.S. was knocked down from AAA to AA+ by Standard & Poor’s, a credit rating agency, last Friday. That downgrade sends a signal that that maybe the U.S. will be less reliable in paying back its debts.

What U.S. debt are you talking about? Mortgage debt? No, consumer debt and government debt work differently. You might take out a car loan, and agree to pay it back at, say, 7%.

U.S. debt is considered an investment. Investors (e.g. you, your mom, China) loan money to Uncle Sam in the form of government bonds (including U.S savings bonds, Treasury bills, notes and bonds)—and Uncle Sam agrees to pay back that debt, depending on its maturity, at a certain interest rate.

Now the downgrade is raising a question, for the first time in financial history: Can Uncle Sam repay its loans?

Does the downgrade relate to the debt ceiling? It’s complicated. When S&P announced the downgrade, they said that the U.S. lacked a viable, unified plan for handling its debt (per the partisan skirmishes over the deficit and debt ceiling debacle).

So even though the Treasury found a math error of about $2 trillion in S&P’s calculations (whoops), and fought the downgrade, S&P did it anyway citing our political failure to create a plan to handle the deficit.

How bad will this get? The downgrade looks like bad news—witness today’s staggering market drop of 500 points and counting. But there’s a lot more going on. The entire globe is in a giant economic mess. There is a debt crisis in Europe that world leaders are also working to stabilize.

Is there any good news here? Hard to say. First, S&P is just one of three credit rating agencies: Moody’s and Fitch are leaving our AAA rating in place (for now). And demand for U.S. Treasury bonds is still high. According to Bloomberg, the Japanese Finance Minister called Treasuries “attractive,” which is reassuring.

At the same time, S&P also downgraded the debt issued by Fannie Mae and Freddie Mac—two mortgage companies that were placed under government oversight in 2008. This has implications for the mortgage market.

What does it all mean? Everyone, even the smartest investors, are swimming around in a sea of unknowns. It’s terribly scary to watch the markets nosedive, but it’s unclear how all this economic news will play out in the coming days, weeks, months.

For that reason, if “wait and see” is good enough for the experts, it’s clearly a smart move for the rest of us, for now.

Hang tight. What’s your read on this global turmoil?