S&P downgrade of US credit rating sends clear message to Congress: shape up

In downgrading the United States credit rating for the first time in its history Friday, Standard & Poor's left little doubt that, for the moment at least, America's debt crisis is, in fact, a political crisis.

The impact of the S&P decision to drop US debt from its top AAA rating to AA+ will not be more fully known until Asian markets open on Sunday night. But the move has the potential to raise interest rates on the national debt – a move that could have the knock-on effect of raising interest rates across the US economy, from mortgages to car loans.

Some evidence suggests the impact could be minimal, however, at least in the short term. Markets have guessed at a looming S&P downgrade for weeks and many might have already adjusted somewhat to account for it. Moreover, US Treasury bonds have been considered such a safe investment for both American and overseas investors for so long that they have become deeply interwoven into the global economy. Buyers might not want to risk now demanding higher interest rates from the US because of the shock it would send through markets worldwide.

And perhaps most important, the two other major credit-rating agencies – Moody's and Fitch – have maintained the US's AAA rating.

But there is no doubt that the S&P downgrade is an alarm bell not only for the US economy, but more particularly for members of Congress. While S&P's ultimate concern is financial – the prospect that the national debt could expand out of control – the reason for the downgrade was congressional dysfunction.

In other words, S&P suggests that the US has the financial ability to head off a debt crisis, but doubts whether it has the political ability to strike the compromises necessary.

"More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned," an S&P statement reads.

Of itself, the recent debt-ceiling deal was not enough to bring federal deficits under control, yet it exposed dramatically the political fault lines that would prevent further progress.

In recent months, "we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon," the statement continued.

S&P appears to taken no sides in the congressional debate. It has given no outward indication of its preference for tax increases, spending cuts, or a mix of both to achieve further deficit savings – or even that it has an opinion on the matter.

What it has done is to warn Washington that it must get to $4 trillion in overall deficit reduction over the next 10 years, according to The Wall Street Journal. The recent debt deal guarantees $2.1 trillion to $2.4 trillion over 10 years.

Mohamed El-Erian, chief executive of bond fund PIMCO, says Congress must treat this as a financial "Sputnik moment."

"For the sake of their country and the wider global economy, both parties should resist the urge to begin bickering," he writes in an opinion piece for the Financial Times. "Instead they should seize this potential 'Sputnik Moment' – a visible shock to the national psyche that can unify Americans around a common vision and a renewed sense of purpose."