Tuesday, 25 October 2011

AA+ passing or failing perception?

The United States credit rating downgraded by Standard & Poor from AAA to AA+ on 5th August, 2011.

Who is Standard & Poor (S&P)?

S&P is a Credit rating agency (CRA), the company issues credit rating for the debt of public and private corporations. It have been designated a nationally recognize statically rating organization by the United States Security and Exchange Commission. It issues rating for both short-term and long-term credit rating.

Are Credit Ratings absolute measures of default probability?

Since there are future events and developments that cannot be foreseen, the assignment of credit ratings is not an exact science. For this reason, Standard & Poor’s ratings opinions are not intended as guarantees of credit quality or as exact measures of the probability that a particular issuer or particular debt issue will default.

The reasons for ratings adjustments vary, and may be broadly related to overall shifts in the economy or business environment or more narrowly focused on circumstances affecting a specific industry, entity, or individual debt issue.

The ratings are not buying, sell, or hold recommendations, or a measure of asset value. Nor are they intended to signal the suitability of an investment.

Primary reason for AA+ is political incapability to handle problems for more than 10 years. And Secondary reason is the rising public debt burden. In USA public debt is more than its GDP.

The U.S. debt-to-GDP ratio is at similar level to what Japan's was at in 2001 when it was downgraded from AAA to AA+ by S&P. Debt – to – GDP ratio is one of the indicator of the healthy economy. It is amount of national debt of a country as a percentage of its GDP. A low debt -to-GDP ratio shows that a large number of goods and services and profits are high enough to pay debt.

As per S&P report on US credit rating downgrade:

1) The downgrade reflects that the effectiveness, Stability and predictability of American policymaking and political Institutions have weakened at a time of ongoing fiscal and economic Challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.

2) We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt limit.

3) Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty.

4) America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.

S&P’s report also includes, the act calls for as much as $2.4 trillion of reductions in expenditure growth over the 10 years through 2021. These cuts will be implemented in two steps: the $917 billion agreed to initially, followed by an additional $1.5 trillion that the Congressional Joint Select Committee on Deficit Reduction is supposed to recommend by November 2011.

If the act implemented S&P still believes that debt burden will likely to grow. Under the S&P revised base case fiscal scenario, which they consider to be consistent with a 'AA+' long-term rating and a negative outlook, they now project that net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021.

In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating. In this scenario, they project that the net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 77% in 2015 and to 78% by 2021.

If it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021.

Lehman Brothers was rated AA few weeks before it collapsed in the same way American International Group (AIG) was rated AAA before it collapsed in September, 2008.

What I believe that AA+ was warning for USA to recheck its political instability and to reform tax system, health care, jobs etc. USA is a giant economy, it will not fail. Dollar is the safest currency in the world and still more than 14000 bonds are rated AAA by S&P. This (August, 2011) downgrade was like alarm bells for the Unites States of America.

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