Just in time for Easter, Standard and Poor’s served up a rotten egg on the United States.They cut the US sovereign debt outlook to negative. At first I almost laughed at the irony. S&P was one of the rating agencies that originally rated all that sub-prime junk that blew up as “AAA”. Now, because the government basically assumed all these private losses and debt to assist the financial markets, they are threatening to cut the rating on the government.Regardless of my disdain for the rating agencies, their opinion does matter and the debt situation in the US could become serious very quickly.“We believe there is a material risk that US policy makers might not reach an agreement on how to address medium-and-long term budgetary challenges by 2013,” S&P noted in its report. “If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.”S&P also indicated that they were assigning a one-in-three chance of a ratings cut in the next two years because of rising budget deficits and the debt.This is the first time the US credit outlook has been questioned since 1995 and 1996, when a dispute between then-President Bill Clinton and House Speaker Newt Gingrich led to government shutdowns.S&P are sending a warning shot and forcing the politicians to seriously consider the implications of their ongoing bickering. They are setting the stage for a potential crisis.But why? Is the US really in such bad shape? For those of you who are not familiar with the fiscal situation I will briefly outline the US’s and most of the developed world’s current predicament.Since 1957, government debt in the US has grown every single year and doubled in the last seven years alone. The US federal debt is now a huge $14.1 trillion or about $127,000 for each household and growing. This does not include the unfunded Social Security obligations which have a present value of about $16.1 trillion as of January 2010.America’s debt to GDP currently stands at about 93 percent. Comparing this ratio to other nations it is not so absurd: Germany is 76 percent, Britain is 81 percent but Italy is 131 percent, Greece is 130 percent and Japan is a staggering 198 percent of GDP.This is high historically for the US and above the 90 percent level at which Carmen Reinhart and Kenneth Rogoff indicate the debt will impair growth. Any change in confidence amongst bondholders may adversely affect the level of interest rates on this growing burden.According to Hayman Capital Management: “Every one percentage point move in the weighted-average cost of capital will end up costing [the US] $142 billion annually in interest alone. Assuming anything but an inverted yield curve, a move back to five percent short rates will increase annual US interest by almost $700 billion annually against current US government revenues of $2.228 trillion (CBO FY 2011 forecast). Even if US government revenues reached their prior peak of $2,568 trillion (FY 2007), the impact of a rise in interest rates is still staggering.”According to professors Carmen Reinhardt and Ken Rogoff in their book, “This Time Is Different: Eight Centuries of Financial Folly”, the average breaking point for countries that finance themselves externally (such as the US) occurs at approximately 4.2 times debt/revenue.This is not a hard and fast rule but clearly the US current ratio of approximately six times is very concerning. In a paper written last year by the Bank of International Settlement entitled “The Future of Public Debt: Prospects and Implications” (Crecchetti, Mohanty and Zampolli) the authors found “debt/GDP ratios rise rapidly in the next decade, exceeding 300 percent of GDP in Japan, 200 percent in the United Kingdom, and 150 percent in Belgium, France, Ireland, Greece, Italy and the United States”.The paper also mentions that government interest expense as a percent of GDP will rise “from around five percent [on average] today to over 10 percent in all cases and as high as 27 percent in the United Kingdom”. The authors state “without a clear change in policy, the path is unstable”.There are positive aspects to consider for America as well, however. The American economy is very resilient and diversified. According to the IMF, America will grow faster than Europe over the next few years and by 2016 should grow twice the pace of Germany.Part of this is the result of having better demographics than other nations. The US also benefits from having the world’s reserve currency. Foreigners hold a huge stock of dollars and Treasuries and therefore they have somewhat of an incentive to support the dollar.On a relative basis, many other regions of the world are not so attractive when compared to the US so in essence America is winning the “ugly contest”. In summary, the sovereign debt situation for America may be manageable but is still a serious issue.What happens if meaningful progress is not made on the debt situation? How bad could a little downgrade really be? A rating below AAA could eventually be devastating to the US economy and as a result to the world economy.American government bond yields are not likely to soar overnight, but if bondholders slowly lose confidence in the US, the cost to borrow money will rise and faith in America would fall considerably.In fact, without some form of credible fiscal reform, every segment of the US society would be faced with some sort of higher borrowing costs, a weaker dollar and likely a less positive outlook for employment, investment and growth.Congress needs a medium-term deficit reduction plan as the longer-term tail risks associated with escalating credit risk would be devastating.The status quo just does not cut it anymore. The current debt situation in the USis uncomfortable but fixable. The S&P outlook gives some sense of urgency to address this. Quoting C Northcote Parkinson: “Delay is the deadliest form of denial.”Nathan Kowalski is the chief financial officer at Anchor Investment Management. He holds a Chartered Financial Analyst (CFA) designation and Chartered Accountant (CA) designation.