WASHINGTON (AP) -- A key credit agency issued an unprecedented warning to the United States government Monday, urging Washington to get a grip on its finances or risk losing the nation's sterling credit rating.
For the first time, Standard & Poor's lowered its long-term outlook for the federal government's fiscal health from "stable" to "negative," and warned of serious consequences if lawmakers fail to reach a deal to control the massive federal deficit.
An impasse could prompt the agency to strip the government of its top investment rating in the next two years, S&P said. A loss of the triple-A rating would ripple through the American economy, making loans more expensive and credit more difficult to obtain.
The downgrade was interpreted as a rebuke to President Barack Obama and congressional Republicans, admonishing them to put politics aside and come up with a long-term financial plan as soon as possible.
"This is a warning: Don't mess around," said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that is pushing for deficit reduction.
Analysts at S&P have never before used the outlook to cast doubt on the nation's credit worthiness.
In response, stocks suffered their worst slide in a month. The Dow Jones industrial average plunged 245 points before recovering to close down 140 points for the day.
"The credit quality of U.S. debt is sacrosanct, and legislators will do everything within their power to avoid a downgrade," said Jack Ablin, chief investment officer at Harris Private Bank.
“Investors trusted credit rating agencies to issue accurate and impartial credit ratings, but that trust was broken in the recent financial crisis,” said Levin. “A conveyor belt of high risk securities, backed by toxic mortgages, got AAA ratings that turned out not to be worth the paper they were printed on. The agencies issued those AAA ratings using inadequate data and outmoded models. When they finally fixed their models, they failed for a year -- while delinquencies were climbing -- to re-evaluate the existing securities. Then, in July 2007, the credit rating agencies instituted a mass downgrade of hundreds of mortgage backed securities, sent shockwaves through the economy, and the financial crisis was on. By first instilling unwarranted confidence in high risk securities and then failing to downgrade them in a responsible manner, the credit rating agencies share blame for the massive economic damage that followed.”
Friday’s hearing will examine case studies involving the two largest U.S. credit rating agencies, Standard & Poor’s and Moody’s. The Subcommittee investigation found that these agencies relied on ratings models that failed to predict default rates for high risk home loans, such as subprime, Option ARM, and interest-only mortgages, that made up an increasingly large part of the market. Documents obtained by the Subcommittee show credit rating analysts also often acted with unclear guidance, uncertain criteria, and incomplete understanding of the complex investments they had to evaluate. The agencies also failed to respond to the higher credit risk posed by mortgage fraud, lax lending standards, and poor quality loans in the marketplace.
From 2002 to 2007, the credit rating agencies earned record profits, reporting $6 billion in gross revenues in 2007. They also allowed the drive for profits and market share to affect ratings. Knowing that Wall Street firms might take their business elsewhere if they didn’t get investment-grade ratings for their products, the agencies were vulnerable to pressure from issuers and investment bankers. As one Moody’s executive wrote in October 2007: “It turns out that ratings quality has surprisingly few friends: issuers want high ratings; investors don’t want rating downgrades; short-sighted bankers labor … to game the rating agencies.”