Skip to Content | Skip to Search | Skip to Navigation
Indiana University

IU expert: Politics underlies economic downgrade

August 9, 2011
Bloomington, Indiana --

It’s impossible to say exactly how the recent lowering of the U.S. national debt rating by Standard & Poor’s will affect the economy, but according to one Indiana University expert, there is nothing good about it.

Image of John Mikesell“The rating agency should have downgraded it three weeks ago,” said John Mikesell, Chancellor’s professor at IU’s School of Public and Environmental Affairs with expertise in government finance and public budgeting.

He said the downgrade of the national debt from its AAA rating by one of several rating agencies — a rating that means the debt is risk-free — would have been appropriate even earlier, when it appeared there was no agreement in sight as to the debt ceiling and some members of Congress were making public statements that they were willing to risk default.

“That was the source of unnecessary embarrassment, monumental stupidity,” Mikesell said.

What influences a debt rating

Factors affecting the U.S. debt rating include the health of the economy, which Mikesell said is “robust” despite the recession, subsequent growth and possibility of another recession.

“We are not South Sudan or a developing country,” Mikesell said. “The economy is OK. And the fiscal factor is also basically OK. We are still paying low rates on the federal debt, and there is no real evidence that anybody is unwilling to loan to us.”

Mikesell blamed the downgrade on politics, as evidenced by the recent wrangling over the debt ceiling and default.

“Governments that are deadbeats get lower ratings,” Mikesell said. “We’ve fallen into deadbeat rating not because we have no money or because of a sour economy, but political choices. It’s a governance question that is creating the real flap.”

Effect on interest rates

Mikesell said the downgraded debt rating will likely result in higher interest rates charged to the federal government, which would have a ripple effect through all financial markets. Local governments, corporations and private borrowers can all expect to pay higher interest rates, and stocks and bonds will decline in value.

This means consumers with variable rate loans or credit card debt tied to the U.S. prime rate could see higher interest rates, as could applicants for new loans and credit.

Tom Risen, president of Bloomington-based United Commerce Bank, was a little more positive, at least as to residential mortgage lending.

“Mortgage rates are extremely low at this time, close to record lows on some products,” Risen said. “It seems that no one knows for certain what the impact of the unprecedented downgrade of the U.S. credit rating will be, though much of what I read indicates that mortgage rates will not be greatly influenced.”

Risen said the continuing recession, high unemployment rates and more stringent government regulations are more of a concern than the debt rating change or stock market drop. But he acknowledged that consumers who have money invested in stocks may have a smaller down payment than they did even a week ago. And negative economic news may make consumers less likely to buy houses.

What’s next?

Mikesell believes unless Congress changes the nature of its discussions about debt limits, the U.S. will continue to fail to meet AAA standards every time the topic comes up.

“The place to constrain deficits is through the regular appropriation process,” Mikesell said. “President Obama can’t spend a nickel on his own. Congress must start being responsible ... the level of debt is the end result of lots and lots of spending choices.”

Mikesell predicts the next “mudfight” and “hand-to-hand combat” in Congress will happen toward the end of September, when its spending authority expires.

“The government may shut down, but so what?” Mikesell said. “That has less long-term consequences than defaulting on debt.”

By Rebecca Troyer
The Herald-Times