If the US Federal government were to lose its AAA credit rating. From the Chairman of Standard and Poors’ credit rating agency via FT and Reuters, September 2008:
There’s no God-given gift of a AAA rating, and the US has to earn it like everyone else.
This went mostly un-noticed. FT continued to pick up on the issue, and noted S&P’s analysis, that if the US government assumed Fannie Mae and Freddie Mac’s liabilities, it would pose a increasing risk to the US’s credit rating. Well the US government did just that, plus provide a $100 billion plus AIG bailout, an unlimited guarantee to the $3.8 trillion money market funds and the funding of $700 billion in bad mortgages. All that goes along with the US Federal debt, which stands at nearly $11 trillion. Not too mention attempts by California and other debt-ridden states to have their own bailout and a possible $25 billion bailout to the US car industry. Then there is Obama’s nearly 1 trillion in new spending.
Japan the second largest national economy in world, is another debt-ridden country, and had its credit rating downgraded in 2002 to AA-. So there is a precedent, but a US rating downgrade would be catastrophic for the world financial system. US debt is by default considered risk-free and is the safe haven for trillions from Japan, China and the UK – being the big three – Australia has limited exposure by comparison. Also, a downgrade in the US Federal rating would make it difficult for other levels of US government to have a higher credit risk rating. There would may also be an impact on US corporation risk ratings, but to a much lesser extent considering that the banking system has already such a low rating.
More recently, CNBC had a segment in which a China analyst suggested that the US might struggle to raise bond capital next year after four European governments had to abandon auctions due to a lack of demand.
“The U.S. might really have to look at a default on the bankruptcy reorganization of the present financial system” and the bankruptcy of the government is not out of the realm of possibility, Hennecke said.
“In the United States there is already a funding crisis, and they will have to sell a lot more bonds next year to fund the bailout packages that have already been signed off,” Hennecke told CNBC.
During the video (can’t post here, but go to CNBC link above) the other analysts basically scoffed at the suggestion that the US might suffer a credit rating downgrade. Their solutions to the problem do not exactly encourage confidence though; tax more and print money. The main problem with these two options is, the US tax base is not large enough to meet all contingent liabilities, including current, future and any possible Obama funding commitments. Secondly, depreciating the US currency through monetary inflation would reduce the uptake of US bonds and hamper attempts to fund the US Federal debt. So all round it’s pretty scary.