There is an increasing concern (at least in the media) that the US government will default on its debt. In our opinion, this fear is overblown. Saving Bonds, T-Bills, T-Notes, and Treasury Bonds are backed by the “full faith and credit” of the US government. Unless you believe that the US federal government is about fall by undemocratic means, or the US economy is heading into a 30 year recession, the possibility of a default is virtually nil.
The S&P downgrade
Much of the recent media coverage on a possible default was sparked by the August 2011 downgrade of US treasury debt by the ratings agency Standard and Poors (S&P) from AAA to AA+. In addition to downgrading the rating by one notch, S&P stated the outlook was negative meaning they expected to make future downgrades.
Who is S&P and how much weight should we put in their ratings?
Standard and Poors is one of most highly regarded credit rating agencies in the world. In fact there is only one firm (Moody’s) which is considered to have equal stature, so when S&P makes a downgrade they tend to have a good reason.
Based on the rating agency’s explanation, the single biggest driver for the S&P downgrade was political risk from the constant standoffs between the Republican-controlled House of Representatives on the one hand, and the White House and Democrat-majority Senate on the other. S&P’s concern was that the push-and-pull, entrenched positions and brinkmanship that has dominated US politics recently is not conducive for the hard economic policy decisions that the US needs to make.
Put differently, S&P does not doubt that the US has the underlying economic strength to meet its financial obligations to bondholders.
This is important because such bitter political standoffs rarely if ever last for more than a decade – such political tension is often resolved after one or two electoral cycles. Also, one should keep in mind that S&P still has as AA+ rating on US Treasury bonds, which is their second highest possible rating. America still holds one of the most elite credit ratings in the world.
Was the US Downgrade Fair?
The countries in the exclusive AAA club include Austria, France, Germany, Switzerland, Norway, United Kingdom, Finland, Australia and Canada. Many economists would argue that France would in fact have been a better candidate for a downgrade, given the exposure of the country’s largest banks to Greek and Italian bonds, as well as its position as a key guarantor for European debt. The UK also has a substantial debt problem, and has faced a destructive collapse of the housing market similar to the US. A strong case can made that the US should not have been the country to be downgraded.
Moody’s did not agree with S&P’s decision to downgrade the US.
They kept the US at their highest credit rating. However, what does the market say about the US credit rating? At the time of writing this article (things can change), both the yield on both French and UK 30 year government bonds are higher than 30 year US Treasury. In other words, more people want to invest in US Treasuries than their higher rated counterparts.Get our free guide to income investing here.