U.S. downgrade would force bond buyers to rethink

July 21, 2011

By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Standard & Poor’s could cut America’s AAA rating even if Congress does a deal on the debt ceiling. That would force a rethink. The 18 other top-rated sovereigns are either caught up in the EU mess or tiny. Without the “risk-free” benchmark of U.S. Treasuries, even ultra-cautious bond investors would have to get used to credit risk.

The United States’ $7.8 trillion of Treasury bonds, notes and inflation-protected securities in public hands, together with more than $5 trillion of federal housing agency paper and the debt of several insurance companies, would all be affected if America’s rating slipped to AA, according to S&P.

For bond investors fixated on AAA credits, there is not much capacity elsewhere to pick up the slack. Other S&P top-rated sovereign entities include the Isle of Man, Guernsey and Liechtenstein, which are tiny. Even the largest of them, Germany, had only 2 trillion euros ($2.9 trillion) of public debt outstanding at the end of 2010. Moreover, six of the entities are euro zone members, and several others are closely connected to the EU’s debt troubles. Only Australia, Canada, Norway, Singapore and Switzerland hold top ratings without such blemishes, but all five have relatively small amounts of debt.

Top-rated companies do exist, but in the United States, for instance, there are only four of them. That is nowhere near enough to absorb investor demand — even assuming buyers could get used to relying on corporate rather than government credit.

Giant U.S. money market funds — obliged to hold almost all their assets in AAA credits — might be spared a huge sell-off in a downgrade scenario because their rules refer to short-term ratings and S&P’s threat might only apply longer-term. For other investors, adjusting portfolio holdings, and even their guiding rules, to include U.S. and other AA-rated names should require only modest changes — though banks and some insurance companies might have to raise a bit more capital. And the U.S. government bond market would still be there, even if interest-rate comparisons with Treasury yields would have to contemplate negative numbers as well as positive.

The biggest impact could be psychological: there would no longer be a globally accepted liquid benchmark viewed as “risk-free”. Fifty years of thinking, and computer models, would need tweaking.


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

I thought it was a fixation on the dollar, not the ratings. Central banks keep trade earnings in dollars to avoid bids on their own currency, to stay competitive. When the subject is the United States, even Reuters speaks in code. So is it 50 years of thinking we need to ponder, or a Yen at 50 dollars?

Posted by threeRivers | Report as abusive

You report that AAA rated creditors only have a small amount of debt.

Go figure!

Posted by Dafydd | Report as abusive

There is nothing to rethink. US will default given the mess the current political situation is in. It is best to accept that US will default and make the appropriate investment decisions

Posted by Tomal | Report as abusive

The problem with credit ratings is that it is viewed as a distinct packet – not as a smooth sliding scale. A downgrade from AAA to AA may in reality mean a small decrease in creditworthiness, but the way rules are written, these distinct packets make it hard for some funds to hold these bonds. Is the Australian AAA the same as say Germany’s AAA? I think we should move away from these distinct packets and have a sliding scale of 1 to 10, where 10 is absolutely risk free (there is no such thing by the way) and 1 is the absolute worst in credit-worthiness. So the US may go from 9.89 to 9.73 because of all the wrangling, but I am sure our human minds comprehend distinct packets more than a sliding scale.

Posted by max_max_mir | Report as abusive