Thursday, July 28, 2011

A Question about the present ‘AAA’ Credit Rating of the USA

Two years back, the word "Credit Default" was never associated with the United States of America. However today it is very difficult to find a financial newspaper or a magazine which does not have an article on a possible US Default if the US government is unable to raise the debt ceiling by an August 2nd deadline.

What is surprising is that all three major rating agencies Fitch, S&P and Moody's maintain the top notch credit rating for the US at this point in time even when a CNN.com article headline reads Countdown to default: U.S. debt talks enter critical week  (CNN might change the headline from time to time as the story develops) . Although imagining such a default by the US is very difficult it is apparent that the probability of defaulting as at this moment is definitely not zero.

Therefore one might question as to why this uncertainty is not reflected in the US credit rating, especially when there is an increased uncertainty about reaching a debt deal.  The author of this article is in the opinion that it is highly counter intuitive to maintain an AAA rating when the "Talk of the town" is about averting a default! A question that one would ask the rating agencies is that even if a deal is reached , and a default is averted does it mean that credit rating should still be AAA ? Or does it even deserve a rating just one notch down from AAA which is AA+ ? The fact that the US is contemplating to avert a default, by all means is an unfavorable situation, where one might not associate a top credit rating.

In stark contrast, the rating agencies were very quick to downgrade Greek debt continuously, even though  the European Union made efforts to agree on a bailout. This made it increasingly difficult for Greece to borrow funds and moved the country even closer towards a possible default. The most recent downgrade of Greek debt by Moody's happened on Monday 25th July 2011.

If the rating agencies continue to maintain the prime (AAA) rating, in case of an unlikely event of a US default, they will have no option but to bring down the rating from AAA to default overnight. An example for such a credit rating downgrade could be found during the recent Sub Prime Mortgage crisis where the AAA ratings of certain CDOs were downgraded to junk status overnight.