MONTGOMERY, AL (RNN) - For the first time in decades, the ability of the U.S. government to pay its debts has been called into serious question, with Standard and Poor's historic downgrading of the nation's AAA credit rating.
The stock market had its first chance to react Monday, and the results were nothing pleasant. All three major U.S. indexes closed down 5 percent or more.
Amidst all the fury, the world's two other chief creditors, Moody's and Fitch, have continued to honor the U.S.'s top notch credit rating.
Fannie Mae and Freddie Mac also downgraded
Standard and Poor's expanded its downgrades Monday to include a plethora of lenders backed by the U.S. government, including real estate giants Fannie Mae and Freddie Mac, who together own more than half of the nation's mortgage debt.
Michael Walden, a professor of economics at North Carolina State University, said that while Standard and Poor's downgrade of the nation's AAA credit rating could bring higher interest rates for consumers who are borrowers, they won't be seen immediately.
Mortgage rates doled out by Fannie and Freddie, which are essentially nationalized entities, will continue to remain low. As the economy weakens, interest rates decrease as investors rush to buy up the very items that have been downgraded: U.S. Treasury securities.
The price for a mortgage loan is based on the treasury index plus a profit spread over that. An increase in the flow of Treasury securities thus counteracts such an increase.
Walter Mooney with the National Association of Realtors said that it remains too early to tell how Monday's downgrading will affect mortgage rates across the nation.
"Mortgage rates are going to move in tandem with U.S. borrowing costs," he said, echoing Walden's words. "Our forecast is for them to gradually increase."
Mooney said a much more serious problem is presently plaguing the real estate market. Reform efforts following the 2008 market collapse have made it near impossible for perspective homeowners to take out mortgages to purchase property. At present, a minimum credit rating of 760 is the market standard.
Lenders should begin to take a value judgment on someone willing to live within their means, rather than basing loans on an artificial credit score, Mooney said, advocating for a return to "common-sense" lending standards.
It turns out that if you can afford it, it's the perfect time to buy a house, and you may want to act before mortgage rates begin the measured increases predicted by Mooney.
"Housing affordability conditions are the highest on record since 1970," he said.
As proof, Mooney said one-third of all Americans home sales this year have been paid in cash, showing the current value in the market.
President Barack Obama also affirmed his belief in the nation's credit worthiness during an address to the nation Monday.
"Markets will rise and fall. But this is the United States of America," he said. "No matter what some agency may say, we have always been and always will be a AAA country."
Dr. Keivan Deravi, a noted economist at Auburn University Montgomery, confirmed that Standard and Poor's decision is not the final word. The agency, which has been criticized for giving AAA credit ratings to mortgage companies who helped contribute to the 2008 housing crisis, is not free from error.
So, just what does this decision mean?
"Really, truly, what they have done is more of a long-term message to the politicians that you have to have a long-term solution," Deravi said.
The impact of Standard and Poor's rating downgrade on consumers will be two-fold, according to Michael Walden, professor of economics at North Carolina State University.
First, consumers will be losers in terms of their investments on equity markets.
"People need to realize that when the stock market goes down, that's a loss of wealth," the economist said.
Evidence of this was already seen Wednesday, as the Dow Jones Industrial average fell more than 600 points. But the week may close on a more optimistic note.
"If no other shoe drops, we'll probably see more rebound in the market over the next few days," Walden said.
Secondly, Walden said there would be higher interest rates for consumers who are borrowers. But while these hikes are likely to come, they won't be seen just yet.
Mortgage rates, for example, will continue to remain low, because as the economy weakens, interest decreases as investors buy up the very items that have been downgraded: U.S. Treasury securities.
Impact aside, Walden does not see another recession on the horizon, which by definition would show six months without market growth.
"But I certainly see very slow economic growth, which for most people will feel like a recession," he said.
Deravi paints a different picture.
States and municipalities who have used U.S. government bonds as their collateral will be negatively affected. Standard and Poor's downgrade says that these bonds are no longer of the same value.
It will now cost these governments more money to leverage their own bonds. The banks that backed those loans may also see some small ramifications.
Beyond that, Deravi said that the impact is nothing more than "psychological" at this point.
The reason is that the U.S. Treasury has been at the backbone of the global financial market for a long time. Simply put, there's no other alternative to U.S. Treasury securities.
"The world has invested so much in this, that there's no way in the short-term that this can be impacted," Deravi said.
However, the economy has been pushed to the verge of recession, Deravi said. Fear, panic and innuendo have confused the public, leaving the odds of a new recession at the close of 2011 or beginning of 2012 twice as high. This could impact job growth and weaken investments.
Deravi said the U.S.'s credibility isn't immune if steps aren't made to reduce debt in the long term.
"For the first time, this has cast a huge doubt on whether we can pay our bills," he said.
If another currency was to emerge, the nation's access to cheap credit at that point could be very limited.
"The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed," reads Standard and Poor's rating action on the U.S. government. "The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy."
Walden said the best solution to appease Standard and Poor's would be for the president, Speaker of the House John Boehner, R-OH, and Senate Majority Leader Harry Reid, D-NV, to come out together and say that they want the nation to do more and are willing to make hard decisions.
"That would hurry us along to getting that higher credit rating back," Walden said.
What Standard and Poor's isn't happy with, the economist said, is the fact that the "harder decisions" haven't been made. Congress has delayed deeper spending cuts by deferring them to the newly-formed, bipartisan, 12-member panel.
"Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures … In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability," Standard and Poor's said of the cuts Congress made in its recent debt ceiling bill.
On Monday, President Obama admitted that the nation's political leaders are embattled.
"We don't need a rating agency to tell us that the gridlock in Washington over the past several months has not been constructive, to say the least," Obama said.
Obama made his first public hints toward compromise in his speech Monday when - in addition to his frequent calls to legislators for tax increase to the wealthy - he said that "modest adjustments to health care programs like Medicare" were necessary.
Walden said the only way the nation's mounting debt can be fixed is through such a bipartisan compromise. Taxes and government spending could be reformed in ways that could appease both parties.
"Apparently, the big agreement that Boehner and Obama made had almost all of that," he said, speaking of tools such as limited tax reductions and Medicaid vouchers.
But that attempt failed miserably. And so the pivotal question is raised: Is a compromise possible in the foreseeable future?
"It's going to be really difficult," Deravi said. "What we have in front of us is a royal mess, because we don't have a majority in the two parties."
It turns out there's something at much greater state for politicians than the long-term credibility of the U.S. government's debt.
"It's all about 2012," Deravi said.
Deravi said that the current political battle in Washington is not based on political lines we have come to know. It's based on very old economic policies that take us back more than 90 years to the pre-Depression era.
That's where the Tea Party and its philosophies lie. The fledgling political ideology believes in a strong private sector and that government resources are far too high. Reform of entities like Social Security, Medicare and "Obamacare" legislation are top priorities on the party's list.
The Tea Party gives the Republicans a majority in Congress. And so, the GOP must appease the party's strict definition of capitalism, something that is not easily satisfied.
And on the other side of the ideological spectrum, compromise would cause Democrats to make great sacrifices and risk alienating their political base.
"The negative that will entail will go against the grain of every Democratic policy," Deravi said.
The end result, according to the economist, is that national economic policies are debated based on political preference rather than a solution to the nation's waning credit rating.
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