One Year Later, Some Upside to America's Debt Downgrade

Sunday marks an event most Americans and investors would probably like to forget: the first-ever downgrade of U.S. debt.

Skyrocketing borrowing costs for the federal government. A massive flight of investors from U.S. Treasuries. General economic chaos and crashing stock prices.

This Sunday marks an event most Americans and investors would probably like to forget: the first-ever downgrade of U.S. debt. And while most of the fears following Standard & Poor's rating cut seem overblown in the rearview mirror, back then the prospect of America losing its pristine triple-A status seemed horrifying and almost apocalyptic.

"There's always the fear of the unknown especially when we've grown up with a Triple-A credit rating all our lives the fear of what would happen if we were downgraded was clearly real," says James Angel, associate professor at Georgetown University's McDonough School of Business.

But instead of plunging financial markets into indefinite disarray and compromising the United States' status as the premier safe haven for investors, quite the opposite happened.

Money didn't hemorrhage from U.S. T-bills. Instead more money funneled into Treasuries as the financial situation in Europe deteriorated and uncertainty plagued markets. The U.S. government didn't face a spike in borrowing costs. Instead investors accepted negative real yields on some notes, meaning the U.S. government was essentially borrowing money from them for free. After a temporary dive, stock markets actually surged to post-crisis highs.

[Read: Economy Takes Center Stage in Swing States.]

"Looking back, a lot of the fears about what would happen—immediate catastrophe—were not met," Angel says. "However the reasons for the downgrade are still there."

And so the legacy of the S&P downgrade isn't necessarily the lowered credit rating itself, according to experts, but the political dysfunction that brought upon the downgrade.

But while the political soap opera in America has spooked markets now and again, the U.S. has one thing going for it: compared to other countries, it's still seen as a safer, better play for investors in many respects. As China grapples with slowing growth and the euro zone struggles to reconcile vastly different economies and cultures to avoid financial ruin, the U.S. is still seen as a refuge from comparatively higher volatility, even with the game of chicken American politicians seem to be playing with the nation's economy.

"We have this unique status in the world," says Marc Doss, California-based regional chief investment officer for Wells Fargo Private Bank. "We still have this political dysfunction but we look a little better than Europe at this point."

Still, the looming "fiscal cliff" could send investors reeling and set up a replay of last year's fiscal tragedy. Investors—and Americans in general—want action and clarity from Congress about how the nation will control and manage its debt, not to mention a clearer picture on the tax code.

[Read: GM Brings More Bad News for Obama.]

"At some point the crisis in confidence because of political dysfunction is going to force our hands, just as it's forcing hands in Europe now," Doss says, mentioning the Simpson-Bowles deficit reduction plan as a plausible starting point for Congressional debate.

"We can't borrow our way to prosperity," Doss adds.

But optimism that Congress can get its act together to avoid another round of brinkmanship when it comes to the economy is wanting.

"We still face all the serious challenges that we faced at that time (of the debt downgrade last year)," Angel says. "I don't see that impasse ending anytime soon and even if one party were to get a narrow majority (in the upcoming election), we will still end up with these political games."

Meg Handley is a business reporter for U.S. News & World Report. You can reach her at mhandley@usnews.com and follow her on Twitter at @mmhandley.

View the original article here