No Downgrade for the U.S.

Moody's and S&P have said that the U.S. government's AAA rating is secure following the move to take over Fannie Mae and Freddie Mac. Earlier, I wrote that when Treasury debt is combined with Fannie and Freddie MBS and company debt, the dept-to-GDP ratio at the end of last year was a little under 75 percent. At what level should the government start to worry about its top-flight rating?

Merrill Lynch's David Rosenberg provides an answer:

The downgrading of Canadian debt in 1995 and Japanese debt in 1998 highlight how far the United States should be from a downgrade of its sovereign debt. In 1995, Canada's debt rating was cut from Aaa to Aa1. At that time, using IMF figures, Canada's gross debt-to-GDP ratio was 114%. Similarly, when Japan's debt was downgraded in 1998 from Aaa to Aa1, the ratio for Japan was 120%.

Using I.M.F. numbers, Rosenberg calculates that with Fannie and Freddie, U.S. debt-to-GDP would be at 84 percent, still significantly below Canada and Japan. But Rosenberg thinks this figure is grossly inflated because the IMF figures include state and local debt but which are not guaranteed by the federal government. He also doesn't like this:

When comparing debt-to-GDP ratios it is necessary to exclude intra-governmental debt. Why? In the United States, this debt is largely comprised of Social Security trust fund debt. This debt represents a promise (incomplete according to the trustees) of a government-run pension plan. Rather than representing "real" debt, it is simply a promise to issue real debt when these promised pensions must be paid out. As each country has different mechanisms for showing pension obligations, it is not clear to us why you would recognize them in the US simply for the accounting feature the US chooses to utilize. Indeed, doing so is arbitrary in the extreme as this measure does not recognize the full cost of Social Security or, even more importantly, Medicare. It is easier (and we believe more correct) to compare current obligations and to consider pension and health obligations when their outlays are financed n the future.

The upshot:
 

...we remain unconcerned that sovereign US debt will face a downgrade. Even if the US were to assume all of the liabilities of the GSEs, history suggests the debt-to-GDP ratio would not reach a level that would prompt that level of concern from ratings agencies...the Treasury is not facing any significant funding restraint despite their recent actions and the anticipated large budget deficit for fiscal year 2009.

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