S&P: Losses Could Pile Up on Debt Standoff

BOSTON (TheStreet) -- Standard & Poor's, which sent global stock markets into a tailspin with its unprecedented downgrade of U.S. government debt Friday, says there may be more turmoil if political leaders don't meet their debt-reduction plans in time.

Failure to hammer out a mutual agreement and a timetable to implement it could lead to additional market losses and higher borrowing costs of everything from books for a regional school district in Nebraska to the price of a General Dynamics ( GD) F-16 fighter jet for the Navy. There could also be unpredictable fiscal austerity measures at all levels of government that often lead to contentious battles among politicians and their constituents. S&P made its remarks in a conference call Wednesday.

Standard & Poor's, which was excoriated for failing to warn investors about the subprime-mortgage debacle three years ago, took a giant step in cutting U.S. government bonds' top rating. After the ratings agency made the decision late Friday, the Dow Jones Industrial Average plummeted 635 points Monday and another 520 points Wednesday, dropping the benchmark index to 10,719. The company's remarks on the ripple effects of the downgrade comes at a time when businesses, local governments and individuals are already feeling the pain of an economy that may be headed toward another recession.

In Washington, a newly formed bipartisan Congressional committee is tasked with coming up with specifics of the debt-ceiling/debt-reduction deal, which includes cutting about $1 trillion in spending over the next 10 years, by Nov. 23.

S&P on Friday lowered the nation's credit rating to AA-plus from triple-A with a negative outlook, and threatened to cut it again in the next two years if politicians fail to meet deficit-reduction goals. The agency also said it's unlikely to upgrade the debt if standards of the plan are met, especially if economic growth remains weak.

Many government entities and companies with financing tied to U.S. Treasuries that are in the process of getting new financing or refinancing may well feel the pinch of higher interest rates sooner rather than later, since their own debt ratings may already have been indirectly reduced.

After downgrading U.S. Treasuries, Standard & Poor's lowered debt issues linked to them Monday, including those of the government-sponsored entities that finance home mortgages such as Fannie Mae ( FNM) and Freddie Mac ( FRM). Also included were municipal bonds that use Treasuries as collateral for financing or as a pricing benchmark, as well as some state and local municipal bonds that are highly dependent on federal aid.

However, some state, regional and local governments can carry higher ratings than Treasuries, S&P's analysts noted, and so not all will see higher borrowing costs.

"When we know the details of the federal-expense-reduction plans, we will update our ratings" of state, regional and local governments, Steve Murphy, S&P's managing director of public-finance ratings, said on the call with Wall Street analysts and the media.

Standard & Poor's also downgraded the debt of the triple-A rated Federal Home Loan Banks and Federal Farm Credit System as well as the ratings on five triple-A rated U.S. insurance firms that have collateral debt tied to Treasury ratings, and $17 billion in debt issued by five other insurance companies.

S&P lowered the ratings on the insurance firms because the nation's "lower sovereign credit rating constrains the long-term ratings on these U.S. insurers because their businesses and assets are highly concentrated in the U.S. and they have significant holdings in U.S. Treasury and agency securities."

Expect to see many similar downgrades in the weeks ahead.

Some corporate bond ratings could also be affected because the market uses Treasury bonds as a reference when pricing other bonds.

But S&P analyst Laura Feinland Katz said high-grade corporate bonds shouldn't be affected by the government downgrade, especially companies that are globally diversified, are in industries "with low reliance on the public sector, have products for which domestic demand is relatively inelastic and low exposure to regulation."

U.S. banks rated by S&P are unaffected by the government's downgrade, the ratings firm said.

S&P analyst Ronald Barone said budget cuts to trim the deficit could impact everything from Medicare programs to not-for-profit schools dependent on government-backed student loans that cover tuition. So, too, are companies that derive a high share of revenue from government contracts. They range from information-technology companies that provide hardware and support services as well as private prison contractors.

S&P sovereign credit analyst Nikola Swann said his firm's rating of France "remains triple-A and the outlook remains stable" as its government has found a resolution for its deficit problems, including means of raising revenue and implementing pension reforms on a timely basis, something the U.S. has failed to do.

Nevertheless, France had to fend off market rumors Wednesday that it, too, is facing a sovereign-debt downgrade, which was likely sparked by the U.S. cut. Those rumors hurt the euro and stocks of French banks.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

More from Rates and Bonds

What's Driving the 10-Year Yield to Historic Levels This Week?

What's Driving the 10-Year Yield to Historic Levels This Week?

U.S. Economy Added 103,000 Jobs in March, Missing Projections

U.S. Economy Added 103,000 Jobs in March, Missing Projections

U.S. Economy Seen Adding Jobs at 'Goldilocks' Pace For Stock Investors

U.S. Economy Seen Adding Jobs at 'Goldilocks' Pace For Stock Investors

Borrowing Costs Surge to Nearly 9-Year High Amid Changing Money Markets

Borrowing Costs Surge to Nearly 9-Year High Amid Changing Money Markets

3 Big Takeaways From Fed Chairman Jerome Powell's First FOMC Meeting

3 Big Takeaways From Fed Chairman Jerome Powell's First FOMC Meeting