U.S. credit downgrade is really about politics, analyses show

August 12, 2011
U.S. credit downgrade is really about politics, analyses show
By Daniel Lippman and Adam Sege | McClatchy Newspapers

WASHINGTON — In Great Britain, riots have devastated portions of the nation's capital and spread to other major cities, leaving the government reeling. In France, the banks are wobbling, buffeted by rumors that they aren't creditworthy and stock price declines that have cost shareholders billions.

But both countries maintain their pristine AAA credit ratings, even as the United States has been downgraded by one major rating agency and two others warn that they might do the same.

What do analysts see in France and England that they're not seeing here? And just what, for that matter, distinguishes a AAA country from a second-best AA+?

Reading the assessments that the rating agencies have produced in recent months on other countries with AAA ratings shows it really is about confidence in the countries' politicians. France and Great Britain get it, according to the assessments, which ordinarily aren't available publicly, but which two major credit rating agencies made available to McClatchy. The United States does not.

Standard & Poor's, in its Aug. 2 report downgrading its assessment of the United States' ability to pay its debts, said that the wide gap between Republicans and Democrats on issues of tax policy and spending made it worry that little will be done to confront the country's burgeoning indebtedness.

Britain faces largely the same economic situation as the United States. Both countries face significantly more government debt than most AAA-rated countries: Last year, general government debt equaled 78.7 percent of the U.S. economy, according to S&P, while in Britain, it equaled 75.2 percent of the economy.

But Britain has held its AAA rating from S&P, largely because S&P thinks that efforts the government proposed last October to cut the deficit will be implemented, even in the face of opposition such as massive student protests late last year over tuition hikes.

"In our view the U.K. government has strong administrative capacity to achieve the expenditure control and revenue-raising laid out in its fiscal consolidation plan," S&P analysts wrote in December, referring to Britain by the initials for United Kingdom.

That expression of confidence that politicians will take the necessary steps to deal with the problem is crucial, said Chris Orndorff, a senior portfolio manager at Western Asset Management in Pasadena, Calif.

"The difference there is that the U.K. has for several months been indicating, not only in talk but in action, a willingness to tackle their problems and to do what's necessary in terms of reducing expenses and raising revenues over a long time period," Orndorff said.

On this side of the Atlantic, however, the deadlock between U.S. political parties over the best path to deficit reduction troubles analysts. President Barack Obama and most Democrats want revenue increases included in a debt-reduction package, but most Republicans support a spending cuts-only approach.

A 12-member congressional panel assigned to find more than $1 trillion in additional deficit-reduction measures by Thanksgiving is made up of six Republicans and six Democrats with diametrically opposed voting records on budget and tax matters, leaving analysts uncertain that they'll succeed in finding a compromise.

Although S&P is the only one of the three major rating agencies to downgrade the U.S., the political impasse also troubles the others. Fitch Ratings said it was encouraged by the debt agreement that Obama signed into law earlier this month, but it warned that it might place a negative outlook on the U.S. later this month.

Moody's, the world's largest rating agency, assigned the U.S. a negative outlook Aug. 2. Analysts saw "similar deficit-reduction objectives" among Democrats and Republicans, they wrote in an explanation of the decision, but the ongoing stalemate about how to reach those goals concerned them.

To determine a rating for a sovereign country, agencies and analysts use a wide array of metrics to assess the level of credit risk. Many of the metrics are statistical, assessing debt and deficit burdens and how future tax and spending plans are likely to affect them.

But politics are a factor too. Countries with AAA ratings typically are politically stable, have growing economies, and debt and deficit figures that are under control. At least 13 major countries and four tiny countries retain their AAA ratings from S&P.

Whatever recipe U.S. politicians choose to reduce the public debt and deficit, S&P analysts are waiting to see credible action before they'll consider restoring the country's AAA rating, the agency wrote in its explanation of the downgrade.

The good news, for Americans and investors, is that several countries have regained AAA status after downgrades. Australia, Denmark, Finland and Sweden lost their AAA ratings in the 1980s or 1990s before regaining them in the early 2000s.

"So it can be done but it takes time," said Joydeep Mukherji, a senior director in S&P's Sovereign Ratings Group. "And in all these cases, it took a fiscal adjustment to change the whole path of deficits."

Canada's so-called "Maple Leaf Miracle" provides a case study. The country lost its AAA rating from S&P in 1992, and by 1994 the general government debt to economy ratio had surpassed 100 percent. Canada regained its AAA rating in 2002, however, four years after passing a balanced budget, its first in almost 30 years.

Canada cut spending and government employees, overhauled its pension plans and saw increased revenues from a national consumption tax that was added in 1991. Eventually the changes worked; last year Canada's general government debt to economy ratio was 85 percent, S&P says.

The U.S. is hardly the only country that might consider studying examples such as that closely.

Rumors of a potential credit downgrade in France dominated the news in that country this week, as investors worried about the strength of the nation's major banks. Shares in France's second-largest bank, Societe Generale, closed down 15 percent Wednesday.

Veronique de Rugy, an economist at the Mercatus Center at George Mason University, said France could be the next country to lose its AAA rating. France has a 9.5 percent unemployment rate, a costly social safety net and the highest debt and deficit ratios among the six AAA-rated countries in the eurozone.

"Changing, reforming things (in France), and moving forward is going to be really hard," de Rugy said. "It's quite stunning that a lot of the country is extremely oblivious or really unwilling to have that conversation about changing the social compact."

Still, despite signs that are concerning to some, France maintains a AAA rating with a stable outlook among all three major rating agencies. An S&P report from February notes high taxes, unemployment and government debt as economic weaknesses, but it expressed confidence in the country's diversified economy.

While Moody's noted weaknesses as well, the agency wrote in May, "the government has demonstrated its ability and willingness to address all of these pressures."

While rating agencies are looking closely for signs of a similar ability among American politicians to address debt issues, S&P analyst Mukherji said it was important to place the downgrade in perspective.

"When you go below AAA, there's almost like another 20 levels to go before you hit default, so going from AAA to AA+ in the grand scheme of things is just a very small step," he said. "AA+ is still a very high rating."

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