S&P rating: Ripple effects of downgrade

@CNNMoney August 6, 2011: 8:11 PM ET

NEW YORK (CNNMoney) -- The United States has lost its AAA rating from credit rating agency Standard and Poor's.

So what happens now?

The reaction might be muted. The United States is the world's largest economy and remains a good credit risk. Even after a downgrade, the government will likely still be able to pay its bills for years to come.

But since this has never happened before, it's difficult to say how the financial markets will respond.

"We've never been through this before. People don't know what to expect," said Ted Weisberg of Seaport Securities, who has spent decades on the floor of the New York Stock Exchange. "So you have to be careful."

First -- the downgrades from S&P probably aren't over.

It's likely that S&P will soon downgrade the debt of mortgage finance giants Fannie Mae and Freddie Mac, along with AAA-rated insurance groups.

Fannie and Freddie, which were taken over by the government in 2008, fuel home sales by purchasing mortgages from banks.

Also facing downgrades are other entities that rely heavily on the federal government -- like the Federal Home Loan Banks, which support consumer credit by making loans to other banks.

Those are the consequences of a downgrade to AA+ as listed by S&P in a report last month.

S&P rating downgrade: FAQ

Highly-rated businesses are expected to be let off the hook. Corporations that are based in the United States that have a AAA rating -- like Johnson & Johnson (JNJ, Fortune 500) -- should keep their sterling credit rating.

The downgrade could also rumble out into the broader economy.

The net effect is difficult to predict, but S&P has offered some ideas about the impact their own downgrade could have on domestic markets.

In July, the agency said it would expect a downgrade to AA+ to result in a moderate rise in long-term interest rates (0.25% to 0.50%) due to "ebbing market confidence."

Also on tap: some slowing of economic growth (0.25% to 0.50%) amid "an increase in consumer and business caution."

The stock markets are where the impact may be felt first.

World markets will get their first opportunity to react when Asian exchanges open Sunday night at 8 p.m. ET.

Some experts expect a rough welcome from the U.S. markets.

"The news that S&P finally pulled the trigger by cutting America's long-term credit rating from AAA to AA+ will surely rock the financial markets when they open on Monday," Capital Economics said in a research note published after S&P's announcement.

But the unrest might not last long.

"Any spike in Treasury yields and/or fall in the dollar should be relatively short-lived," the note said. "Once the dust settles, attention will turn back to the economic fundamentals, which are certainly consistent with low Treasury yields."

The effect on money markets and other institutional investors required to hold highly-rated debt is likely to be minimal.

U.S. booted from Triple-A debt club

Moody's and Fitch -- the two other major credit rating agencies -- have both maintained their AAA rating on U.S. debt, making it unlikely that large funds will be required to move out of Treasuries.

And the Federal Reserve said Friday night that it would still treat government debt as high grade, a move that alleviated fears that a downgrade could gum up the gears of short-term lending.

It's also possible that pretty much nothing will happen.

Japan endured a downgrade without a strong long-term reaction. And many observers have argued that since the fiscal situation of the U.S. is very well known, the impact of a downgrade will be minimal.

Fed Chairman Ben Bernanke articulated that view in April when S&P placed the United States on credit watch.

"S&P's action didn't really tell us anything," Bernanke said. "Everybody who reads the newspaper knows that the United States has a very serious long-term fiscal problem."

In the long-term, the psychological reaction to the downgrade might have the biggest impact.

"This just reinforces the negative -- and this is last thing you want to do," Weisberg said. "You want investors to think the glass is half full. "  To top of page

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