Will America Lose Its AAA Credit Rating?

On November 7th, Merrill Lynch released a report stating that the U.S. had one of the "ten most vulnerable economies" in the world. The report included in the list of the "world’s ten least vulnerable economies" Russia, as well as Nigeria, Egypt, Oman, and Peru.

Yesterday, the credit ratings of 10 countries - including Russia - were downgraded.

Today, a front-page story on CNBC says:

"The United States may be on course to lose its 'AAA' rating due to the large amount of debt it has accumulated, according to Martin Hennecke, senior manager of private clients at Tyche."

Remember, credit rating agencies, such as Standard & Poor's, Moody's and Fitch, assign credit ratings to countries, as well as companies.

A September 18 article in Bloomberg raised the possibility of a credit downgrade for the U.S.:

America's credit "profile is now weaker because contingent risks have become actual risks to the U.S. government,'' said John Chambers, managing director of sovereign ratings at Standard & Poor's in New York.

In fact, Standard & Poor's raised a possible downgrade of U.S. credit back in April. An article in Marketwatch explained:

The performance of government-sponsored enterprises like Fannie Mae could have a direct impact on the national economy and more importantly, the credit standing of the U.S., Standard & Poor's said Monday.

Fannie and Freddie, which enjoy implicit government guarantees, could cause the U.S. to lose its sterling triple-A rating if the government were forced to come to their rescue, the ratings agency said in a report.

"Even though...credit damage from GSEs is unlikely, the greater risk to the U.S. lies with them than with broker-dealers," S&P noted.

The demise of Bear Stearns Cos. - and the Federal Reserve's extraordinary efforts to alleviate strains at broker dealers - has captured the attention of market participants who feared that the financial system would seize up last month.

S&P, however, noted that while this credit crunch has caused financial markets to swoon, it hasn't threatened the standing of the nation's credit quality upon which U.S. Treasurys and the debt priced off this government debt depend.

But should a protracted recession cause Fannie and Freddie to buckle, S&P said, the U.S. rating would be in danger.

Of course, the Fannie and Freddie did buckle, and the government was forced to take them over. Indeed, even after the takeover, Fannie just announced a $29 billion dollars loss. In many other ways, the health of the U.S. economy is much worse than it was in April, and the U.S. is spending literally trillions of dollars it doesn't have on corporate bailouts.

A 2005 article in Lew Rockwell called "Should the US Government’s Sovereign Credit Rating be Downgraded to Junk?" provides some details of how credit rating agencies assign credit ratings to countries:

When examined objectively, one could make the case that Uncle Sam’s sovereign credit rating should be downgraded – perhaps even to "junk." So where are the credit rating agencies? Are they going to miss this one just like Enron?

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Both Moody’s Investors and Standard and Poor’s have granted the U.S. the highest sovereign credit rating possible (Aaa and AAA respectively). Most other countries are less fortunate and have lower credit ratings – which can affect such a country’s interest rates and access to the credit markets. The lower the credit rating, it is believed, the higher the chances are for a country to default on its sovereign debt obligations. Be aware S&P downgraded Japan’s sovereign credit rating to AA– on April 15, 2002 . . .

The article then analyzes the U.S. economy using 8 traditional credit-rating factors, and concludes that the U.S. has performed abysmally in all 8:

Having gone through all eight variables, it should be obvious that both Moody’s and Standard & Poor’s have grossly overrated America’s sovereign debt – it doesn’t merit the top grade of AAA. In variables such as default history, inflation, external balance, external debt, and economic development, the U.S. should rate significantly lower than does Japan – and should rate worse in many variables as compared to a developing country such as Botswana.

So why hasn't America's credit rating been downgraded?

Well, a report by Moody's in September states:

"In superficially similar circumstances, the ratings of Japan and some Scandinavian countries were downgraded in the 1990s.

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For reasons that take their roots into the large size and wealth of the economy and, ultimately, the US military power, the US government faces very little liquidity risk — its debt remains a safe heaven. There is a large market for even a significant increase in debt issuance."

So Japan and Scandinavia have wimpy militaries, so they got downgraded, but the U.S. has lots of bombs, so we don't? In any event, American cannot remain a hyperpower if it is broke.

Any way you look at it, America's credit rating will be downgraded. Its just a question of when.