Our debt rating explained

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Today news is flowing in about S&P reducing the rating of the United State’s debt for the first time ever. We had the highest rating (AAA), but now are a AA+ (one step down from the highest).

Talking heads on both sides of the isle are blaming the other side of the isle for the problem. Let’s look at this a little closer.

  • Democrats were saying if we didn’t increase the debt ceiling, our rating would drop. We raised the debt ceiling, and the rating dropped anyway.
  • Republicans are saying that it’s the Democrat’s runaway spending that’s to blame. Who’s right?
Debt is a simple thing to understand, unless you deliberately over-complicate things.
Debt, in its simplest terms, is negative money. It’s money that you’ve already spent that you haven’t yet earned.
Money that’s given out is either “earned”, “donated”, or “loaned”:
  • Donated money is money that’s given away “freely” with no requirement to repay it.
  • Earned money is money that you traded goods and/or services for.
  • Loaned money is money that you haven’t yet earned, that’s given with the promise that you’ll repay it at a later date along with some “interest”, “fee”, or other usury. This is “debt”.
Now that we’re clear on what “debt” is, let’s move along.
In days of yesteryear we had something called “underwriting”. Oversimplified, this was accomplished by a process wherein a persons debts were weighed against their assets. One asset that’s often overlooked is one’s ability to earn money. Today, this process has primarily been replaced by your “credit score” or “credit rating”. This scores essentially ignores your assets and instead focuses on proprietary data points that include the amount of credit you have, the amount of your monthly payments on that debt, timeliness of those payments, and so on.
To make your credit score go up you:
  • make your payments on time
  • make more money (income)
  • have less debt
  • have a lower “debt ceiling”
Okay, so what’s a “debt ceiling”? Simply put, it’s how much money you can borrow; it’s your credit limit.
The higher your credit limit, even if you haven’t used any of it, the lower your credit score could be. Essentially, if you have a $50,000 credit limit on four cards, but only owe $1,000 total, you’re not in good shape because you could at any time accrue an additional $49,000 in debt. Who would want to lend you money with that looming over your head?
The solution?
  1. Make your payments on time
  2. Pay off your debt
  3. Close the accounts that you’ve paid off
  4. Make more money
Now, apply that to the Federal Deficit:
  1. We are still making our payments on time
  2. We aren’t paying off any of our debt — in fact we’re going deeper and deeper into debt
  3. We aren’t closing any of our accounts (these are programs that we’re obligated to pay off like Social Security, Medicare, Medicaid, Foreign Aide, 5 wars, etc.), and Congress is asking for more!
  4. We haven’t made any more money (raised taxes)
Is it any surprise that our credit rating was dinged? If we don’t make some hard decisions and make some serious cuts, can you see any way out of this pit?
Neither do I.

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