Could America Really Lose Its Triple A Rating?

In today’s Financial Times, there is an op-ed article by David Walker, the CEO of the Peter G. Peterson Foundation pondering the possibility of the U.S. losing its prized AAA credit rating. The paper focuses on a warning that was issued by rating agency Moody’s months ago. Moody’s has not issued a new warning, yet Walker and in turn, the FT has decided to re-inject uncertainty into the financial markets by resurrecting this fear. What has prompted this article is most likely the recent comments about the insolvency of the Social Security and Medicare systems. According to the trustees for the systems, the Social Security trust fund could be depleted by 2037 while Medicare could be insolvent by 2017. These dates of insolvency have been pushed up as the weak labor market reduces contributions. The Obama Administration has pressed the importance of gaining control of the growth in Medicare costs and their desire to tackle Social Security insolvency once health care reform is passed.

According to Walker, if the health care reforms strains finances further or if the federal government fails to monitor spending, tax or budget control, rating agencies could strip the U.S. of its credit rating.

Is Losing AAA Rating that Big of a Deal?

But is losing the AAA rating that big of a deal? Yes. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt. Some global funds are mandated to invest only in AAA debt and therefore if the U.S. loses its AAA rating, we could see a massive outflow of foreign investment. Also, a credit rating downgrade is the perfect excuse to push through an alternative reserve currency to replace the dollar because it would strip the confidence of sovereign funds like China that have been buying dollars to prop up the U.S. economy. Yes, investors will still buy U.S. Treasuries, but their purchases will be less. It could also have a spillover effect on corporate debt and will raise the cost of borrowing for the U.S. government.

How Real is the Risk?

Now with the risk in mind, I think that ratings agencies talk a good game but they will problems following through. The consequences of downgrading U.S. sovereign debt is huge both politically and economically. Therefore Moody’s or any rating agency for that matter may be reluctant to the first to pull the trigger. Downgrading the U.S. is very different from downgrading Ireland. Based upon how the rating agencies have handled the credit derivatives bubble, chances are they will be behind the curve once again.

With that in mind, U.S. finances are deteriorating significantly, raising the concern of Asian nations. However if President Obama is successful at turning around the U.S. economy, America will be well equipped to meet its debt obligations.

[ad#minivan]

8 Comments

  1. One good way to monitor the relative credit of the US is through sovereign CDS (Credit default swap) rates. A lower basis point number (bps)reflects lower risk.

    From being near 80 bps back in Feb, the US rate now stands around 23bps today. That compares with Germany (25), France (27). Italy (75) UK(61) and Japan (50) are all much higher. The really bad ones – Poland (159), Fed of Russia 276) and Iceland (781) for comparison…

    I track these weekly in my brief. If the US starts to creep upwards, it might be a prelude to this sort of risk event.

    Reply
  2. I simply don’t see how the US could possibly lose its AAA rating. Why, we pay good money for those ratings…

    its just darned lucky that the ratings come from a privately-held US corp (Moodys, S&P etc) subject to payoffs and favors, than a central, objective agency like the IMF or OECD.

    Otherwise, we might have lost the AAA rating back when Nixon canceled Bretton Woods and took the US off the gold standard in 1971.

    Reply
  3. Are there any alternative ratings agencies besides the Moody’s, Fitches, and S+P’s?
    I am surprised that there are no Japanese, Singaporean, Arab, or even Chinese ratings agencies. Surely these respective nations have more of a stake in what happens to Western fund flows?

    Reply

Leave a Reply to Paul Stafford Cancel reply