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United States of America Long-Term Rating Lowered To 'AA+' Due To Political Risks, Rising Debt Burden; Outlook Negative

Publication date: 05-Aug-2011 20:13:14 EST


  • We have lowered our long-term sovereign credit rating on the United States of America to 'AA+' from 'AAA' and affirmed the 'A-1+' short-term rating.
  • We have also removed both the short- and long-term ratings from CreditWatch negative.
  • The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics.
  • More broadly, the downgrade reflects our view 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.
  • Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon.
  • The outlook on the long-term rating is negative. We could lower the long-term rating to 'AA' within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.
 
TORONTO (Standard & Poor's) Aug. 5, 2011--Standard & Poor's Ratings Services 
said today that it lowered its long-term sovereign credit rating on the United 
States of America to 'AA+' from 'AAA'. Standard & Poor's also said that the 
outlook on the long-term rating is negative. At the same time, Standard & 
Poor's affirmed its 'A-1+' short-term rating on the U.S. In addition, Standard 
& Poor's removed both ratings from CreditWatch, where they were placed on July 
14, 2011, with negative implications.
     The transfer and convertibility (T&C) assessment of the U.S.--our 
assessment of the likelihood of official interference in the ability of 
U.S.-based public- and private-sector issuers to secure foreign exchange for 
debt service--remains 'AAA'.
     We lowered our long-term rating on the U.S. because we believe that the 
prolonged controversy over raising the statutory debt ceiling and the related 
fiscal policy debate indicate that further near-term progress containing the 
growth in public spending, especially on entitlements, or on reaching an 
agreement on raising revenues is less likely than we previously assumed and 
will remain a contentious and fitful process. We also believe that the fiscal 
consolidation plan that Congress and the Administration agreed to this week 
falls short of the amount that we believe is necessary to stabilize the 
general government debt burden by the middle of the decade.
     Our lowering of the rating was prompted by our view on the rising public 
debt burden and our perception of greater policymaking uncertainty, consistent 
with our criteria (see "Sovereign Government Rating Methodology and Assumptions
," June 30, 2011, especially Paragraphs 36-41). Nevertheless, we view the U.S. 
federal government's other economic, external, and monetary credit attributes, 
which form the basis for the sovereign rating, as broadly unchanged.
     We have taken the ratings off CreditWatch because the Aug. 2 passage of 
the Budget Control Act Amendment of 2011 has removed any perceived immediate 
threat of payment default posed by delays to raising the government's debt 
ceiling. In addition, we believe that the act provides sufficient clarity to 
allow us to evaluate the likely course of U.S. fiscal policy for the next few 
years.
     The political brinksmanship 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. Despite this year's wide-ranging debate, in our 
view, the differences between political parties have proven to be 
extraordinarily difficult to bridge, and, as we see it, the resulting 
agreement fell well short of the comprehensive fiscal consolidation program 
that some proponents had envisaged until quite recently. Republicans and 
Democrats have only been able to agree to relatively modest savings on 
discretionary spending while delegating to the Select Committee decisions on 
more comprehensive measures. It appears that for now, new revenues have 
dropped down on the menu of policy options. In addition, the plan envisions 
only minor policy changes on Medicare and little change in other entitlements, 
the containment of which we and most other independent observers regard as key 
to long-term fiscal sustainability.
     Our opinion is that elected officials remain wary of tackling the 
structural issues required to effectively address the rising U.S. public debt 
burden in a manner consistent with a 'AAA' rating and with 'AAA' rated 
sovereign peers (see Sovereign Government Rating Methodology and Assumptions," 
June 30, 2011, especially Paragraphs 36-41). In our view, the difficulty in 
framing a consensus on fiscal policy weakens the government's ability to 
manage public finances and diverts attention from the debate over how to 
achieve more balanced and dynamic economic growth in an era of fiscal 
stringency and private-sector deleveraging (ibid). A new political consensus 
might (or might not) emerge after the 2012 elections, but we believe that by 
then, the government debt burden will likely be higher, the needed medium-term 
fiscal adjustment potentially greater, and the inflection point on the U.S. 
population's demographics and other age-related spending drivers closer at 
hand (see "Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even 
More Green, Now," June 21, 2011).
     Standard & Poor's takes no position on the mix of spending and revenue 
measures that Congress and the Administration might conclude is appropriate 
for putting the U.S.'s finances on a sustainable footing.
     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 newly formed Congressional Joint Select Committee on Deficit 
Reduction is supposed to recommend by November 2011. The act contains no 
measures to raise taxes or otherwise enhance revenues, though the committee 
could recommend them.
     The act further provides that if Congress does not enact the committee's 
recommendations, cuts of $1.2 trillion will be implemented over the same time 
period. The reductions would mainly affect outlays for civilian discretionary 
spending, defense, and Medicare. We understand that this fall-back mechanism 
is designed to encourage Congress to embrace a more balanced mix of 
expenditure savings, as the committee might recommend.
     We note that in a letter to Congress on Aug. 1, 2011, the Congressional 
Budget Office (CBO) estimated total budgetary savings under the act to be at 
least $2.1 trillion over the next 10 years relative to its baseline 
assumptions. In updating our own fiscal projections, with certain 
modifications outlined below, we have relied on the CBO's latest "Alternate 
Fiscal Scenario" of June 2011, updated to include the CBO assumptions 
contained in its Aug. 1 letter to Congress. In general, the CBO's "Alternate 
Fiscal Scenario" assumes a continuation of recent Congressional action 
overriding existing law.
     We view the act's measures as a step toward fiscal consolidation. 
However, this is within the framework of a legislative mechanism that leaves 
open the details of what is finally agreed to until the end of 2011, and 
Congress and the Administration could modify any agreement in the future. Even 
assuming that at least $2.1 trillion of the spending reductions the act 
envisages are implemented, we maintain our view that the U.S. net general 
government debt burden (all levels of government combined, excluding liquid 
financial assets) will likely continue to grow. Under our revised base case 
fiscal scenario--which we consider to be consistent with a 'AA+' long-term 
rating and a negative outlook--we 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. Even the projected 2015 ratio of sovereign indebtedness is high 
in relation to those of peer credits and, as noted, would continue to rise 
under the act's revised policy settings.
     Compared with previous projections, our revised base case scenario now 
assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, 
remain in place. We have changed our assumption on this because the majority 
of Republicans in Congress continue to resist any measure that would raise 
revenues, a position we believe Congress reinforced by passing the act. Key 
macroeconomic assumptions in the base case scenario include trend real GDP 
growth of 3% and consumer price inflation near 2% annually over the decade.
     Our revised upside scenario--which, other things being equal, we view as 
consistent with the outlook on the 'AA+' long-term rating being revised to 
stable--retains these same macroeconomic assumptions. 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, we 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.
     Our revised downside scenario--which, other things being equal, we view 
as being consistent with a possible further downgrade to a 'AA' long-term 
rating--features less-favorable macroeconomic assumptions, as outlined below 
and also assumes that the second round of spending cuts (at least $1.2 
trillion) that the act calls for does not occur. This scenario also assumes 
somewhat higher nominal interest rates for U.S. Treasuries. We still believe 
that the role of the U.S. dollar as the key reserve currency confers a 
government funding advantage, one that could change only slowly over time, and 
that Fed policy might lean toward continued loose monetary policy at a time of 
fiscal tightening. Nonetheless, 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.
     Our revised scenarios also take into account the significant negative 
revisions to historical GDP data that the Bureau of Economic Analysis 
announced on July 29. From our perspective, the effect of these revisions 
underscores two related points when evaluating the likely debt trajectory of 
the U.S. government. First, the revisions show that the recent recession was 
deeper than previously assumed, so the GDP this year is lower than previously 
thought in both nominal and real terms. Consequently, the debt burden is 
slightly higher. Second, the revised data highlight the sub-par path of the 
current economic recovery when compared with rebounds following previous 
post-war recessions. We believe the sluggish pace of the current economic 
recovery could be consistent with the experiences of countries that have had 
financial crises in which the slow process of debt deleveraging in the private 
sector leads to a persistent drag on demand. As a result, our downside case 
scenario assumes relatively modest real trend GDP growth of 2.5% and inflation 
of near 1.5% annually going forward.
     When comparing the U.S. to sovereigns with 'AAA' long-term ratings that 
we view as relevant peers--Canada, France, Germany, and the U.K.--we also 
observe, based on our base case scenarios for each, that the trajectory of the 
U.S.'s net public debt is diverging from the others. Including the U.S., we 
estimate that these five sovereigns will have net general government debt to 
GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the 
U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP 
ratios will range between 30% (lowest, Canada) and 83% (highest, France), with 
the U.S. debt burden at 79%. However, in contrast with the U.S., we project 
that the net public debt burdens of these other sovereigns will begin to 
decline, either before or by 2015.
     Standard & Poor's transfer T&C assessment of the U.S. remains 'AAA'. Our 
T&C assessment reflects our view of the likelihood of the sovereign 
restricting other public and private issuers' access to foreign exchange 
needed to meet debt service. Although in our view the credit standing of the 
U.S. government has deteriorated modestly, we see little indication that 
official interference of this kind is entering onto the policy agenda of 
either Congress or the Administration. Consequently, we continue to view this 
risk as being highly remote.
     The outlook on the long-term rating is negative. As our downside 
alternate fiscal scenario illustrates, a higher public debt trajectory than we 
currently assume could lead us to lower the long-term rating again. On the 
other hand, as our upside scenario highlights, if the recommendations of the 
Congressional Joint Select Committee on Deficit Reduction--independently or 
coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax 
cuts for high earners--lead to fiscal consolidation measures beyond the 
minimum mandated, and we believe they are likely to slow the deterioration of 
the government's debt dynamics, the long-term rating could stabilize at 'AA+'.
     On Monday, we will issue separate releases concerning affected ratings in 
the funds, government-related entities, financial institutions, insurance, 
public finance, and structured finance sectors.
 
RELATED CRITERIA AND RESEARCH
 
This unsolicited rating(s) was initiated by Standard & Poor's. It may be based 
solely on publicly available information and may or may not involve the 
participation of the issuer. Standard & Poor's has used information from 
sources believed to be reliable based on standards established in our Credit 
Ratings Information and Data Policy but does not guarantee the accuracy, 
adequacy, or completeness of any information used.
Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.

Primary Credit Analyst:Nikola G Swann, CFA, FRM, Toronto (1) 416-507-2582;
nikola_swann@standardandpoors.com
Secondary Contacts:John Chambers, CFA, New York (1) 212-438-7344;
john_chambers@standardandpoors.com
David T Beers, London (44) 20-7176-7101;
david_beers@standardandpoors.com

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