DBRS Assigns AAA Rating with Stable Trend to the United States

DBRS Inc. (DBRS) has today assigned AAA issuer ratings on the long-term foreign and local currency debt of the United States of America. The trend on both ratings is Stable. The ratings reflect the underlying strengths of the U.S. economy, which is highly productive and diversified, flexible in response to external shocks and, at 27% of global GDP, the world’s largest economy. Further supporting the ratings are the country’s institutional strength and the preeminence of the U.S. dollar as the world’s largest reserve currency, facilitating low financing costs and a high degree of funding flexibility. These attributes give the Treasury a very high capacity to service debt, even during periods of high investor risk aversion.

However, starting with the 2007-2009 credit crisis and continuing to the current economic recovery, macroeconomic fundamentals have come under significant downward pressure. The chain of events that began with the overleveraging of household and financial sector balance sheets, coupled with lax lending regulation and supervision, led to the collapse of the housing market, severe stress on financial institutions, and contributed to the global recession of 2008-2009. Subsequent government initiatives to restore health to the financial sector significantly increased the government’s contingent liabilities.

Add to these factors a collapse in tax revenues plus rising spending from automatic stabilizers and some discretionary outlays, and the result has been a sharply higher central government deficit, which peaked at 10% of GDP in 2009, and a level of indebtedness that is expected to peak at 103% of GDP in 2013, well above those of other AAA-rated countries. Protracted policy discussions through August 2011 over how to cut the deficit and create the conditions for a faster restoration of growth, led to severe market volatility.

Despite these pressures, DBRS is encouraged by an eleventh hour fiscal agreement struck on August 2, 2011, which demonstrated a renewed commitment to reducing the deficit and stabilizing debt-to-GDP over the medium-term. The Obama administration, meanwhile, is focusing on creating jobs and fostering real economic activity in the near-term. DBRS believes that the August 2 Budget Control Act (the act) is likely to result in a large fiscal adjustment. The act requires $917 billion (approximately 4.5% of GDP) in deficit reduction measures between 2013 and 2021, and raises the debt ceiling by $900 billion. The act also aims to identify an additional $1.5 trillion in measures, which, once approved by a Joint Select Committee on Deficit Reduction, would be immune from amendments or filibuster.

If the Joint Select Committee fails to identify savings of at least $1.2 trillion by November 23, 2011, then Congress will grant a $1.2 trillion increase in the debt ceiling and automatic across-the-board spending cuts, or “sequestration”, of $1.2 trillion, to be equally divided between security and non-security programs. The cuts would apply to mandatory and discretionary spending from 2013-2021, and include Medicare providers. Either the original measures identified by the Joint Select Committee or the automatic procedures must be approved by December 23, 2011. The process of approving sequestration would be similar to the Base Realignment and Closure (BRAC) commission process created by Congress, which successfully closed politically sensitive U.S. domestic military installations by decree, sparing politicians from the consequences of the closures.

DBRS believes that implementation risk will remain significant. If fully executed, the renewed commitment to fiscal adjustment should succeed in stabilizing debt-to-GDP. Should this occur, it would further underpin existing rating levels. Longer term, addressing structural pressures from Social Security, Medicare and Medicaid will be important to maintaining a sustainable fiscal position. Events that could result in the assignation of a Negative trend include the inability to effectively execute the Joint Select Committee’s fiscal reduction measures, or the alternative sequestered measures. If the U.S. economic outlook sharply deteriorates over the coming months, a strong medium-term fiscal consolidation plan will be all the more urgent.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the U.S. Treasury, the Federal Reserve, the Office of Management and Budget, the Bureau of Economic Analysis, the Congressional Budget Office, the Bureau of Labor Statistics, the IMF, and the World Bank. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is the first DBRS rating on the United States of America.

Lead Analyst: Fergus J. McCormick
Rating Committee Chair: Alan G. Reid
Initial Rating Date: September 8, 2011
Most Recent Rating Update: September 8, 2011

For additional information on this rating, please refer to the linking document under Related Research.