Could the U.S. Lose Its AAA Rating?

B-Riz notes a WSJ story on the possibility of the U.S. government losing its triple-A rating. Barry, rightly, thinks S&P isn’t brave enough (though he alluded to their “stones”).

To me, it’s a hugely frivolous issue. U.S. Treasuries receive a credit rating every day. It’s better known as the price. I don’t see how some rating from a questionable firm could possibly have an impact greater than price movements. If anything, a downgrade would merely confirm what the market is already saying.

There’s also the fact that the government owns the printing press, so they’ll get those dollars to bondholders one way or another.

I would go as far as saying it’s safe to look past all forms of debt measurements and ratios, and concentrate on Treasury yields. Is the debt too high? Depends, what are T-bonds yielding? If their yields are going up, then yes. If not, then I’m not concerned.

There are lots of good reasons for lower debt. But long-term nominal GDP growth can easily top current yields.

Comments

[chrism1962]

If the US does lose its AAA rating, the ramifications could be huge. What has not been taken into consideration is the effect it will have on the confidence of the sovereign funds that are propping up the US economy by buying T Bills, Etc.

If the downgrade does take place, yields will have to rise, to keep the buyers happy. You cannot simply keep printing more cash, as the USD will tumble, and the buyers will stop buying T Bills.

The worst case scenario is sovereign funds selling T Bills to buy Euro denominated, or other currency denominated bonds. If this occurs, T Bill yields will have to rise significantly, to keep bankrolling the US economy.

[EtoileBrilliant]

Eddy, I can see where your analysis is coming from but I would have to comment that its a little intro-spective. Whilst there is a good argument that domestic lenders (or investors) would be more or less unmoved by a downgrade of the US, I'm inclined to think that external investors might have an alternative view.

Given that the US is the world's largest debtor nation, I'm absolutely certain that a downgrade would result in a parallel shift in the yield curve. The benchmark might become the German Bund or more likely one of the Supras (although their ratings might be affected given the contributions the US make to their balance sheet).

Regardless, of whom takes on the mantel of the provider of the "risk free rate of return", this will only lead to a further weakening in dollar (maybe even the final death throes everyone has been anticipating).

In the long term, I'm actually very bullish about the USD. However, I'm keeping my money in other currencies until this particular alcoholic has reached the step one of the twelve step programme ("We admitted we were powerless over "debt" - that our lives had become unmanageable")

[CrossProfit]

EtoileBrilliant,

"step one of the twelve step programme" [U.K. spelling]

Just a figure of speech or do you actually have a 12 step analogy?

As an aside and for general knowledge purposes only, is the AA a 12 step program?

[Chungst]

Having worked in corporated credit for a number of years -- first as in the commercial lending business and later as a buy-side analyst in High Yield & High Grade funds -- I don't think people understand what it means to have a "AAA" corporate credit rating (per S&P) or senior implied rating (per Moody's). Keep in mind the S&P ratings methodology on corporate bonds is transparent; each year, S&P provides a free copy of its Corporate Ratings Criteria (I was orginally introduced to it in my Level II CFA exam) that goes in depth of their ratings approach. If the rating is not "AAA" then it is AA+ because there is no "AAA+" or "AAA-" ratings in the S&P ratings universe for corporate bonds. That is to say if the WSJ claims the rating is not "AAA," then the burden is show or prove what is the correct rating and why. Telling us that it isn't "AAA" is insufficient in my book.

Here are a few more comments to think about:
1) It's not a case of S&P not being "brave enough", it's a case of following the transparent S&P ratings methodology (please note, the 2006 edition was 128 pages).
2) I had the opportunity to speak with Sol Samson and Scott Sprinzen (2 of the main contacts listed in the 2006 ratings methodology book) many times when I was following the auto the sector. From 2002 to 2004, S&P was guiding investors on Ford's arrival into junk status and a lot of investors and critics didn't give S&P enough "credit" for their work. I have transcripts of those calls and Mr. Samson made it clear his job is to make sure the analyst get the ratings right! That is to say S&P demonstrated the courage to get the ratings right even though it meant disappointing investors (who were obviously in the denial state!) that wanted Ford to remain an investment grade credit.
3) Credit analysis is an art that is a science and a science that is an art. Having worked with all four rating ratings -- S&P, Moody's, Fitch, and DBRS, I would say S&P tends to be the most quantitative-driven of these four firms. This is good because it means their ratings are replicable, especially in light of the transparency of the rating methodology. That is to say, given so many people can replicate S&P ratings with high degree of accuracy (the 2-factor model I've developed is 95% accurate), then WSJ or other critics need to show via the hard data why the "AAA" is incorrect due to "ratings dynamism."

Cheers

[EtoileBrilliant]

Sir,

I am a Wiki-plaguerist, check out this link:

en.wikipedia.org/wiki/...

I hope this helps.

EB

[JohnPseudonym]

What good is the rating system?

How many bonds have had AAA ratings only to get into trouble and have the rating lowered?

What good is that?

A car is AAA certified. I buy it. The engine blows up. They change the rating to FFF and say there was no way to see the coming engine failure...

So, after it's too late, I find out my AAA car should have been tagged FFF; thanks a lot...

[Kunst]

Chungst:
So do you believe the US could lose its AAA rating?
If so, what results would follow?

[Bond Guy]

Every one says the federal government never defaults giving them an AAA rating. They default all the time through inflation. You're right, they own the printing press. They don't have the dollars to pay, they just print more...or find another wonderful way to tax us.

[GeoffreyT]

I'm a bit late into this thread, but ...

Did the article in question canvas the idea that there are spillover effects from the ratings on sovereign debt through to the ratings on corporate debt? {I confess, I didn't read it - anything that is in the WSJ is almost certainly six months late and parsed to within an inch of its life... plus I am a very very very lazy man).

As I understand it, while the loss of the US' AAA rating would not a fortiori <b>cause</b&g... the downgrading of ALL US-based debt rated AA+ and above, it would be very likely to cause all such corporate debt to be placed on review.

That said, both S&P and Moody's talk a good game, but frankly they have never been in front of the curve in the 20 years I've been watching their abysmal performance. Tell me one disaster they have seen coming before bond markets themselves... they are famous for downgrading stuff two days after the caca hits the air conditioner. The only people I have known who worked for S&P/Moodys were very nearly innumerate. Nice blokes, but I wouldn't want them to be assessing the creditworthiness of a bake sale.

Cheerio


GT
France