Risks to U.S. AAA Rating Have Grown

Includes: DIA, SPY
by: SA Eli Hoffmann

Today, S&P affirmed its AAA rating and stable outlook for the United States, but said risks to the country's top sovereign rating have increased since September.

In September, S&P's John Chambers said pressure was building on the U.S. AAA rating after the $85B bailout of AIG (NYSE:AIG): "There's no God-given gift of a 'AAA' rating, and the U.S. has to earn it like everyone else."

Below are excerpts from today's ratings release.

We have affirmed the ratings on the U.S. despite our judgment that fiscal risk has noticeably increased, as we expect that the fiscal deterioration will be temporary and that the country's other credit strengths will withstand current pressures.

The ratings on the U.S. primarily reflect our opinion of the sovereign's high-income, highly diversified, and exceptionally flexible economy. The ratings also reflect our view of its strong track record in terms of growth-enhancing policies, as well as the unique advantages coming from the U.S. dollar's role as the key international currency. In our opinion, these strengths continue to outweigh the U.S.'s weakening current-year fiscal performance, growing risks in its financial sector, longer term challenges associated with its entitlement programs, and the nation's weak external position.

We observe that the U.S. has one of the most flexible economies of any high-income nation, with both exceptionally adaptable labor markets and a long track record of openness to trade and capital flows, and a competitive and innovative private sector. In addition, the U.S. dollar is by far the world's most used currency.

Nevertheless, risks to the U.S. credit profile do exist, and we judge these to have risen since September 2008. In particular, we believe the deepening financial turmoil and related global macroeconomic downturn will lead to noticeable deterioration in the U.S. fiscal profile.

We currently expect the U.S. general government (that is, federal unified budget plus state and local governments) deficit, already weak at 5% of GDP in fiscal year 2008, to double in 2009. This is a result of both softening revenue sources and the incoming Obama administration's 2009 fiscal stimulus package, which we expect to approach $1 trillion, or 7% of GDP. Even with such fiscal contributions, we still expect the U.S. economy to contract by 2% in real terms in 2009, before beginning to recover in the second half of that year.

Our own stress tests lead us to believe that, in a reasonable worst-case scenario, net general government debt could rise from its 2008 level of 42% of GDP to as much as 75% by 2011, combining the costs of bailouts and stimulus with the fall-off in revenue. Indebtedness of this magnitude, while a noticeable deterioration, would still be consistent with ratios of closely comparable peers such as the U.K., France, and Germany (all rated AAA/Stable/A-1+), and in itself would not jeopardize the rating on the U.S. so long as the sovereign's other credit fundamentals remain in place.

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