S&P CUTS U.S. DEBT RATING TO DOUBLE A PLUS / THE FINANCIAL TIMES ( VERY HIGHLY RECOMMENDED READING )

Last updated: August 6, 2011 12:59 pm

S&P cuts US debt rating to double A plus

By Robin Harding in Washington and Aline van Duyn and Telis Demos in New York


Standard & Poor’s has downgraded the US credit rating by one notch from triple A to double A plus in a contentious and historic move that highlights the weakened fiscal stature of the world’s most powerful country.


“There are two things that we should emphasise. One is that the political discourse has diminished the credit standing of the United States. The other is a fiscal analysis,” John Chambers, managing director and chairman of the sovereign ratings committee at S&P, told the Financial Times.


S&P said that the long-term outlook for the US remains negative and it could lower the rating further to double A within the next two years if there is less spending reduction than that agreed to under the debt ceiling deal this week, a rise in US interest rates or US debt climbs on a higher trajectory.


The move is the first ever downgrade of the US by a leading rating agency and could send shockwaves through markets, pushing up US bond yields at a time of economic vulnerability, and creating a long-term threat to the status of the US dollar as the world’s reserve currency.


Peter Fisher, head of fixed income at BlackRock, the world’s largest asset manager, said that the implications of a downgrade on the broader debt markets were difficult to predict. An important factor to watch would be the knock-on effects on other debt ratings.


On Monday, S&P will announce the result of its ratings review on entities linked to the US government, such as housing finance agencies Fannie Mae and Freddie Mac. A downgrade is considered likely because S&P has emphasised the entities’ link with the sovereign rating in the past.


“The odds are very high that there would be knock-on consequences of other borrowers getting downgraded – both corporate and public, in the US and overseas,” said Mr Fisher in a note to investors. “What really ends up happening is a downward shift of the entire spectrum of fixed-income securities,” he said. Broader downgrades “would be a signal to all types of investors to re-examine their risk appetite.”


The US Federal Reserve quickly moved to reassure banks after the S&P announcement, saying that it will continue to accept Treasuries as collateral as usual and that banks will suffer no capital penalty for holding US government debt.


“The decision by Standard & Poor’s has no implications for the operation of the Federal Reserve’s discount window or the conduct of open market operations,” said the Fed.


China on Saturday criticised Washington in a strongly worded statement through the official state news agency Xinhua.


The statement said that the US only had itself to blame and called for a new stable global reserve currency.


“The US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” the statement said. “China, the largest creditor of the world’s sole superpower, has every right now to demand the United States address its structural debt problems and ensure the safety of China’s dollar assets.


“International supervision over the issue of US dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country,” Xinhua said.


The rating downgrade could impact US mortgage rates which are pegged to the price at which the US government borrows money.


Mr Chambers said that S&P did not doubt the effectiveness of the $2,100bn in deficit cuts agreed as part of the deal to raise the debt ceiling. “It is more a matter of whether we get additional measures that will stabilise [the] debt/GDP [ratio].”


The downgrade followed an extraordinary row which put the move on hold for hours on Friday afternoon after the agency had notified the administration of its decision.


The US Treasury department found – and S&P accepted – thousands of billions of dollars of errors in some figures used by the rating agency.


The Treasury went on the attack over the quality of S&P’s analysis, saying that “a judgment flawed by a $2,000bn error speaks for itself”.


Early on Friday afternoon, S&P sent the Treasury a draft release that said net public debt would rise to 93 per cent of gross domestic product by 2021. By 4pm local time, analysts at the Treasury had replied that the numbers were wrong, according to a person familiar with the matter.


S&P’s initial numbers were based on the ‘Alternative Fiscal Scenario’ prepared by the Congressional Budget Office. That assumed that discretionary federal spending would grow in line with the economy. S&P then subtracted the roughly $900bn in savings created by the debt ceiling deal to estimate net debt.


However, the CBO had calculated the $900bn savings from a different baseline, which assumed that spending would grow in line with inflation. Calculated from the higher alternative scenario, the budget savings would be closer to $3,000bn. Adjusting for this would mean that net public debt would rise to only 85 per cent of GDP by 2021.


From S&P’s point of view, however, the number did not make a difference to forecast deficits, only the debt-to-GDP ratio calculation. S&P believed that the difference changed the ratio by only 1.5 percentage points through 2015 and did not affect the trajectory of debt-to-GDP.


It also did not affect the political factors regarding Washington’s ability to tackle the deficit, which influenced S&P heavily.


“The political brinkmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy,” S&P said in its report.


But the administration argued that political analysis is subjective territory for a rating agency and that S&P rushed to judgment without recognising the merits of the fiscal deal or future deficit reduction to come.


Some market participants were sympathetic. “It’s a headline grabber that may shake Main Street confidence, but I’m confident it won’t result in higher Treasury rates,” said Jack Ablin, chief investment officer at Harris Private Bank. “I believe it will have little market impact near-term. There’s a global glut of savings with few safe havens. The US, Japan and Italy are the three most liquid sovereign bond markets. Which would you want?”
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Copyright The Financial Times Limited 2011