One of the main reasons for the downgrade by S&P is the political deadlock before the raise of the debt ceiling. The last minute agreement of raising the debt ceiling initiated worries about the default and concerns on risk-free. Actually from this, many people may have thought about the possibilities of the default first time in their life. However, is there actually a possibility of US default?
Still, many people do not doubt about the US’s capacity to pay debt. The worries come from the politicians’ incompetency to come to an agreement, which almost passed the deadline this time. However, even though politicians came near the deadline, there was no possibility of missing the deadline to raise the ceiling as people worried. Imagine what would have happened if the government did not raise the ceiling and declared default. Among a crash of the market, extreme downgrade, and other damages, the most severe damage would be a loss of the credibility. By losing the credibility, US bonds/debts and dollars would become much less popular; thus US’s financing ability would deteriorate, which would, unlike 2008 crisis or any other crisis (recoverable), permanently damage and shrink US economy. Without credibility and the greatest economy of the world, US will significantly lose its influence and a position as the world leader. Basically it will lose the values that it has built since the history of US started. Furthermore unlike the default due to incompetency, US nation and other countries (lenders to US) will feel betrayed and violently angered if it defaults because the politicians cannot compromise. Therefore, even though politicians may come to the last minute, they will bring to an agreement no matter what because resulting defaults is worse than anything for the politicians.
In addition, another reason for the downgrade was insufficient debt reduction. S&P think US need $4 trillion debt reduction while government agreed with $2.7 trillion. However, less debt reduction is not because government cannot do it since they could also raise taxes, and there were more rooms to cut spending. Which means the government can reduce more debts if they think necessary later. Therefore, it is highly doubted that the debt to go out of government control and grow to amount of uncontrollable. Therefore, this reason is also unacceptable for the downgrade.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.