Will credit-rating agencies downgrade US debt? Sadly, it doesn’t matter. This is why
It’s final exam week at my university. As usual, students are concerned about “making the grade”.
So too are U.S. lawmakers. To avoid spending cuts to some or all government program to meet current interest payments, Congress must pass legislation to raise the so-called debt ceiling. Missing an interest payment could risk a reduction in the “grade” on U.S. Treasury debt; that is, its credit rating.
The grading system for both private and public debt is operated by credit rating agencies. The three largest agencies – Fitch, Moody’s and Standard and Poor’s – account for almost all rating activity in the bond market.
The U.S. now holds the highest rating of AAA. More risky debt receives a lower grade, such as AA or BBB. By their own standards, credit agencies say debt with lower ratings should pay a higher interest rate, since the risk of default is higher. However, this is often not the case.
More than a decade ago now, Japanese government debt was downgraded from AAA, but the annual interest rate on 10-year Japanese government bonds continues to be lower than that of U.S. debt. The U.S. government pays more than 3% interest annually over the same period that Japan’s government pays less than 1%. In the 1990s, Canada lost its AAA rating but has since regained it. Nonetheless, yields on Canadian government bonds remain below those of U.S. bonds.
Earlier this year, Moody’s issued a negative outlook for debt issued by the government of Italy, which at Baa was already below that of most developed countries. Despite a much lower grade than the U.S. has, 10-year Italian bonds pay only 0.5% more.
Even if Congress can reach an agreement to raise the debt ceiling, the rating agencies may still downgrade U.S. debt. Should current spending levels continue, the increasing amount of government debt outstanding could result in a lower rating like those of other countries.
U.S. government debt outstanding amounts to more than its annual income, or gross domestic product. A household with this kind of debt would undoubtedly receive a credit score preventing the household from borrowing any further.
All this goes to show that the government bond-grading system is not what it used to be. Government bonds are widely purchased no matter the credit risk.
It doesn’t appear the U.S. has to worry about final exams, as grades don’t seem to matter.
Peter Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa, Idaho. prcrabb@nnu.edu
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