How Are Credit Ratings Being Affected by the Economic Crisis?

United States consumers' credit ratings have been affected by two key developments: the Credit Card Accountability Responsibility and Disclosure Act of 2009 and the national economic crisis that began the recession in December 2007.

The economic recession, which has caused more than $75 billion in foreclosure actions, has also hurt individual credit ratings, with the rate of individuals seeking employment lingering around 10 percent, while the more inclusive measure of people who are seeking work, or have given up looking for work, or are underemployed) remained at 16 percent or more in the first fiscal quarter of 2010.

AAA Credit Rating

The ballooning of the federal deficit by record spending led Moody's Investors Service to warn the government in 2010 that if spending continues to disproportionately leverage against the Gross Domestic Product, the United States' AAA rating (also referred to as a bond rating) would be downgraded to AA. Few investment services and market analysts see this as likely. But it had a profound trickle-down effect on consumer credit ratings, because lending institutions took on greater risk of insolvency among sliding credit markets.

Rising deficits without economic growth impeded new foreign investment dollars, and the U.S. dollar weakened on foreign exchanges. With the dollar losing some of its worth, credit ratings for individuals dropped as credit card account balances rose when investment funds lost gains.

2009 Credit Card Act

The Credit Card Accountability Responsibility and Disclosure Act of 2009 was a series of new regulations on credit card companies and banks. It requires credit card companies to inform cardholders of any significant account changes within 45 days, and it limits interest rate increases. Credit card companies and banks enacted many of the prohibited measures ahead of the act being signed into law. Consequently, some consumers saw huge interest rate hikes, new fees, reductions in credit lines, or outright account cancellations, all of which harmed their credit ratings.

Credit Freezes

In February 2008, President Bush signed into law the Economic Stimulus Act, designed to make solvent or prop up lending institutions and investment firms to curb the recession. The stimulus money given to banks was supposed to be passed on in the form of personal loans, installment loans, and business loans. But banks froze credit lines, fearing loan defaults.

Because banks did not lend the money, individuals relied on established credit lines and/or credit cards for funds, hurting their debt-to-income ratios.

Pre-Recession

Until the recession of 2007, investor and consumer credit was freely granted. And from 2004 through 2006, the Federal National Mortgage Association and the Federal Home Mortgage Corp. were politically pressured to loan to people who did not qualify for traditional mortgages. Real estate investors and developers also took advantage of easy credit. Both conditions set prices artificially high, and home values fell when the boom collapsed.

Consequently, in 2007 many homes were valued at less than their outstanding mortgage balances. Homeowners were paying mortgages out of line with the market value of their houses.

Consequences

Consumer credit ratings began to decline in earnest as the recession continued through 2008 and 2009. As the U.S. federal debt climbed, banks and investment institutions began restricting credit access. Businesses began downsizing or froze expansion plans. Unemployment rose, and people had less money. Many consumers made just minimum monthly payments on their credit cards, paying only interest without amortizing the principal balance, weakening their overall creditworthiness.