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Downgrade’s impact on consumer wallets

By D.C. Denison
Globe Staff / August 9, 2011

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Standard & Poor’s downgrade of the United States’ credit rating to AA+ from AAA on Friday, and its subsequent lowering of Fannie Mae and Freddie Mac’s credit yesterday, further roiled already turbulent financial markets, fraying nerves and making a double-dip recession closer to reality. But the effect of the rating agency’s actions on consumers will probably be more subtle - at least for now - according to local financial advisers.

What exactly did Standard & Poor’s do?

The ratings agency downgraded its grade for the federal government’s long-term debt from the highest possible mark, AAA, to AA+. Yesterday, it downgraded the credit ratings of Fannie Mae and Freddie Mac and other agencies linked to long-term US debt.

What does that mean to me as a consumer?

Lower credit ratings often lead to higher interest rates for bonds - because there is a greater chance of default, buyers get paid more to take on the added risk. As a result of higher interest on Treasury bonds, the rates that consumers pay on mortgage and auto loans - both of which are keyed to Treasurys - could go up. And that, in turn, could lead to higher prices on just about everything, if the situation doesn’t improve.

"Long-term, the downgrade is going to mean inflation," said Rob Lutts, president of Cabot Money Management of Salem.

But how likely is it that mortgage loans and other borrowing will soon cost more?

A credit rating downgrade does not automatically translate into a rise in interest rates. Treasury bonds are still considered among the safest and most liquid investments in the world, so even if the cost of borrowing goes up, financial planners say, the don’t expect dramatic increases. In fact, the demand for Treasurys was so strong yesterday - as investors sought refuge for their money - interest rates on those bonds went down.

"The Federal Reserve is going to do everything it can to keep interest rates low, and it has more influence than Standard & Poor’s," said Bill Driscoll, owner of Driscoll Financial, a financial planning firm in Plymouth.

But Driscoll said that if the yet-to-be-appointed congressional committee charged with making deeper budget cuts by the end of the year does not act decisively, the US credit rating will probably be lowered more, not only by Standard & Poor’s, but by the other two rating agencies.

A failure by Congress to deal with the national debt in a big way "may have a more dramatic effect on the nation’s credit rating, and the economy," Driscoll said.

As the stock market has fallen, so have oil prices. Isn’t there some good news here - cheaper gas and heating oil?

Crude prices are indeed at their lowest levels since November, driven down by the belief that a slower-growing - or receding - economy will lessen demand for oil. So yes, gas and heating oil prices may drop. But probably not for long - demand from emerging markets, especially China, will eventually put upward pressure on prices, even if the US economy slumps.

With the stock market in full-speed retreat and consumer spending down - on top of the credit downgrade - are we going into a "double-dip" recession? If so, how bad could it get?

Double-dip recession refers to the economy sliding into reverse after a brief recovery. Cheryl Costa, managing director of AFW Wealth Advisors, and a personal finance blogger for Boston.com, said that the S&P downgrades will not, by themselves, cause the economy to recede. But an emotional reaction to the bad news of late - by investors and consumers gripped by fear - could start building downward momentum.

"The S&P downgrades should have been non-events," Costa said. "But what we saw in [yesterday’s] stock drop is an overreaction. Fear and panic have a way of feeding on themselves, and that’s what’s going on here."

In fact, Costa said, many corporations are still doing quite well, and even the latest employment numbers "aren’t so bad."

She’s advising clients to "turn off the TV and do something else other than dwelling on the bad economic news."

"If people start yanking their money out of the stock market, and hoarding money rather than spending because they are now gripped by fear," Costa said, "that could bring on a downturn."

Should I be moving my money somewhere before I lose even more?

Probably not, especially if it’s invested long-term - such as in a retirement plan - say financial planners.

"The downgrades are having an emotional impact, a visceral one, but it’s unlikely to have the kind of impact that calls for dramatic action on the part of the average consumer," said Daniel J. Galli, principal at Daniel J. Galli & Associates, a financial planning firm in Norwell. "The S&P downgrade will not change the fact that the US is still the safest place for a large institutional investor to put money."

Even as yesterday’s financial markets were in freefall, Driscoll said it was the wrong time for consumers to make dramatic financial moves.

"If you don’t need the money, stick to your guns," he said. "This is not the time to change your strategy. A down market is not the time to sell."

D.C. Denison can be reached at denison@globe.com.