U.S. Debt Downgrade: A Looming Concern for Your Portfolio
Updated: Sep 21
Understanding the Foundations: U.S. Debt
The U.S. national debt—that $36+ trillion figure that is again dominating headlines—represents the accumulated borrowing of the federal government to cover budget deficits accrued over time. When government spending exceeds revenue, the Treasury issues marketable securities—bonds, bills, notes, and other instruments—to finance the shortfall.
These Treasury securities function as the bedrock of global financial markets. Foreign governments, institutional investors, and ordinary citizens purchase them not merely as investments but as safety nets—the proverbial mattress under which the prudent tuck their savings during uncertain times. Traditionally, U.S. Treasuries have occupied the "risk-free" corner of investment portfolios, allowing investors to take calculated risks elsewhere. The thinking goes that, if you're going to assume risk in your investments, you should seek commensurately greater rewards through equities. This calculus functions smoothly—until new uncertainties emerge in what were previously considered unassailable safe havens.
The Debt Ceiling: America's Self-Imposed Financial Straightjacket
The debt ceiling—a legislative construct dating back to 1917—establishes the maximum outstanding debt the federal government can legally incur. When the government approaches this limit, Congress must raise or suspend it to continue borrowing and paying existing obligations. Critically, raising the debt ceiling doesn't authorize new spending; it merely permits financing previously approved expenditures.
What was once a routine legislative procedure has transformed into political theater of the highest order. Since 1960, Congress has adjusted the debt ceiling 78 times—49 under Republican administrations and 29 under Democratic leadership. However, particularly since 2011, these votes have become increasingly fraught with brinksmanship and partisan wrangling.
Credit Rating Agencies: The Financial World's Judgment Panel
Credit rating agencies—Standard & Poor's, Moody's, and Fitch—evaluate the creditworthiness of debt issuers, including sovereign nations. Their assessments influence borrowing costs and market perception worldwide. These agencies examine multiple factors when rating government debt, including:
Fiscal performance and debt-to-GDP ratios
Economic stability and growth prospects
Monetary policy effectiveness
Institutional strength and governance
Political stability and policy predictability
And why does a credit rating matter? From Standard & Poor’s:
Credit rating adjustments may play a role in how the market perceives a particular issuer or individual debt issue. Sometimes, for example, a downgrade by a rating agency may change the market’s perception of the credit risk of a debt security which, combined with other factors, may lead to a change in the price of that security.
The United States has historically maintained the highest possible credit ratings, a reflection of its economic might, institutional stability, and the dollar's reserve currency status. This privileged position has enabled relatively inexpensive government borrowing while providing a benchmark for global interest rates.
The Specter of Downgrade: When America's Credit Score Falters
A debt downgrade occurs when rating agencies reduce their assessment of a borrower's creditworthiness. For sovereign nations, downgrades typically reflect deteriorating fiscal positions, governance concerns, or increasing default risks.
The United States has experienced two significant downgrades in recent history:
August 2011: Standard & Poor's downgraded U.S. debt from AAA to AA+ following a prolonged debt ceiling crisis. S&P cited "political brinksmanship" and inadequate fiscal consolidation plans as key factors.
August 2023: Fitch Ratings downgraded the U.S. from AAA to AA+, citing "expected fiscal deterioration," growing debt burden, and "erosion of governance" manifested through repeated debt ceiling standoffs:
The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA' rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.
Fitch's rationale highlighted several disturbing trends:
Projected U.S. debt-to-GDP ratio reaching 118.4% by 2025—more than double the median for AAA-rated countries
Increasing mandatory spending on Medicare and Social Security
Rising interest costs consuming an ever-larger portion of tax revenues
Looming trust fund insolvencies in Medicare (projected 2035) and Social Security (projected 2033)
In short, the credit agencies don’t like the possibility of the US government not being able to meet its financial obligations. Remember, at the beginning, how I noted that the debt ceiling enables the Treasury to pay already incurred debts. If the Treasury exceeds the debt ceiling, and Congress doesn’t vote to increase that ceiling, the Treasury will be hamstrung and unable to pay those debts.
Present Concerns: Political Polarization Meets Fiscal Reality
The current landscape presents a paradoxical situation. President Trump has expressed support for eliminating the debt ceiling entirely, stating it would be "the smartest thing" Congress could do. "I just don't want to see a default. That's all I want," Trump told reporters in December. Surprisingly, this is much more in line with Democrats’ positioning on the issue, than Republicans’, as Congressional Democrats have long advocated for abolishing the debt ceiling, introducing legislation like the "End the Threat of Default Act," which has yet to gain significant traction. Indeed, Former US Rep John Yarmuth, Chairman of the House Budget Committee at the time, and democrat of Kentucky, asked of the debt ceiling:
[W]hat good is this policy? In short, it's not. The United States is the only major industrialized nation to have a debt limit, and there is no evidence to show that it has ever actually constrained borrowing, influenced fiscal decision-making, or spurred any useful reforms. The mere existence of this policy has potentially catastrophic consequences for all Americans, while providing no benefit to our nation. It must be abolished now.
But Trump may have an uphill battle, as congressional Republicans have historically championed the debt ceiling as a mechanism for fiscal restraint. As Senator Ron Johnson, R-Wis., recently warned: “Don’t do away with it. It’s the only leverage we have.” To achieve Trump’s apparent wish to get rid of the debt ceiling, the less fiscal hawkish Republicans would have to work with Democrats. Not to be a cynic, but I’m not going to hold my breath for this one.
The political winds seem to have already shifted since Trump’s December exhortation to dump the debt ceiling: Republicans are now figuring out how to simply raise the ceiling without Democrat support. But unanimous Republican support may be hard to get, as “dozens of current GOP lawmakers are opposed to raising the debt ceiling on principle and have never voted to support an increase to the nation’s borrowing limit.” So we may just be facing another debt ceiling standoff, which the credit rating agencies have already warned us against.
Not helping the situation? This political schizophrenia occurs against a backdrop of deteriorating fiscal metrics:
Increasing interest costs consuming a growing share of federal revenues
Aging population driving entitlement spending growth like Social Security and Medicare, costing the government more
Concern about a potential economic slowdown or recession on the horizon, further reducing GDP and worsening the GDP to Debt ratio
Implications for Investors: When the "Risk-Free" Asset Carries Risk
A U.S. debt downgrade—distinct from an actual default—carries significant implications for investors:
Bond Market Turbulence: Treasury securities might experience price volatility and yield increases as markets reassess risk premiums. That is, if you own a bond and then the credit agencies downgrade the creditworthiness of that bond, you will probably have to sell the bond at a discount if you want to get rid of it. What you bought has essentially lost value because it has lost creditworthiness and become riskier.
Dollar Depreciation: The U.S. dollar's reserve currency status could face incremental erosion, potentially reducing foreign demand for dollar-denominated assets.
Global Financial Ripples: With over half of global foreign currency reserves held in dollars, diminished confidence could trigger portfolio adjustments worldwide.
Higher Borrowing Costs: Corporations and consumers might face increased interest rates as the "risk-free" benchmark adjusts upward.
It's crucial to distinguish between a downgrade and a default. A downgrade merely reflects a changed risk assessment, while a default would involve the government failing to make scheduled payments—something the United States has never experienced and would likely trigger global financial chaos.
Portfolio Strategy: Preparing for Uncertainty
A prudent investor acknowledges both the historical resilience of U.S. Treasury securities and the evolving risk landscape. Consider these strategic adjustments:
Individual Bonds vs. Bond Funds: Individual bonds held to maturity insulate investors from interim price volatility, provided no default occurs. Bond funds, conversely, never mature and remain subject to market pricing.
Conclusion: Vigilance Without Panic
The recurring debt ceiling drama and potential for additional downgrades warrant attention without necessitating wholesale portfolio abandonment of U.S. government securities. The American economy's foundational strengths—innovation capacity, institutional depth, and global economic leadership—provide substantial buffers against catastrophic outcomes.
Nevertheless, investors would be wise to monitor fiscal developments, diversify fixed-income holdings, and perhaps maintain slightly higher cash positions during periods of heightened uncertainty. The time to consider these adjustments is now—not when debt ceiling brinkmanship dominates headlines and markets experience acute volatility.
In finance, as in much of life, sustainable success derives not from predicting precise outcomes but from positioning portfolios to withstand various scenarios while capturing appropriate returns for assumed risks. The evolving U.S. fiscal situation merely underscores this timeless principle.
Ms. Money is written by Marisa Rothstein, JD, CFP(t), AEP, and Lead Financial Advisor at Siena Private Wealth, A Member of Advisory Services Network, LLC.
Nothing contained in this article should be construed as investment, legal or tax advice. Consult your tax or legal advisor regarding your situation. To learn more about Siena Private Wealth, visit: www.sienaprivate.com. All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC.
Comments