Economic Insights

U.S. Sovereign Risk: Never Say Never?

Sovereign risk has been almost a daily fi xture in the headlines for over a year, although until this past week most of it was focused on Europe. Europe’s headline dominance has been due both to the severity of its debt crisis and the diffi culty in fi nding a satisfactory resolution from the perspective of the capital markets. Despite numerous resolution efforts and initiatives by the European Central Bank (ECB), the International Monetary Fund (IMF) and the European Union (EU), the situation remains far from resolved. Spreads on Greece, Ireland, Portugal, and Spain bonds all reached record levels last week amidst widespread market expectations that bondholders will not get made whole, especially on Greek bonds. And Portugal has joined Greece and Ireland in needing to tap into the European bailout fund. Globally, there have 26 downgrade rating actions for sovereigns but only fi ve upgrades thus far in 2011.

But that is the rest of the world. This week it was the United States’ turn to grab the
sovereign risk headlines as Standard & Poors (S&P) reaffi rmed its AAA ratings on $9
trillion of publicly held U.S. government debt, but more importantly changed its outlook
to negative.

S&P’s accompanying report noted that “...our rating on the U.S. sovereign signals that we believe there is a likelihood of at least one-in-three of a downward rating adjustment within two years.” An obviously unhappy Obama administration and Treasury probably took little comfort in the added note from S&P that “if we do lower the rating, it would be by no more than one notch to AA+.” Ironically, S&P’s warning that it might downgrade the U.S. to a level below AAA for the fi rst time since government ratings began in 1941 came on the heels of efforts by both Republicans (led by Congressman Paul Ryan) and the Democrats (led by the Obama administration) to put proposals on the table to reduce government debt and defi cits. But those proposals are widely divided, especially on the issue of using tax hikes to help resolve the fi scal challenges facing the federal government.