What Would a U.S. Debt Downgrade Mean?

Kevin Drum opines that the US government losing its AAA rating wouldn't have much effect:


I can't speak for Obama, but I have a feeling that the significance would be: zero. Granted, there's symbolic importance to something like this, and on a substantive level there are certain funds that are legally prohibited from holding non-AAA debt. So fine: maybe not quite zero.

But U.S. debt is simply too big, too public, and too widely followed for ratings agencies to have much influence over it. Everyone knows what the problems with the American economy are, and no one thinks that the folks at Moody's or S&P know any more about it than anyone else. They just don't have any special expertise to offer here. A downgrade might provide an opportunity for some short-term arbitrage, but beyond that it's not clear if it would have any effect at all. It's the market that determines the price of U.S. debt, not the ratings agencies.

I agree that a US debt downgrade wouldn't be a surprise. But it would certainly have an effect, particularly on the portfolio of institutional investors who have regulatory or contractual mandates to only hold top-rated, ultra safe bonds. And that would certainly be felt in the market for US debt, as all those institutions were forced to unload. How bad the effects would be would depend on how far we were downgraded.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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