Analysis: If U.S. loses triple-A, its citizens will pay

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Analysis & Opinion
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By Daniel Trotta
NEW YORK | Mon Apr 18, 2011 6:02pm EDT
(Reuters) - The U.S. dollar would dive. The housing and auto industry recoveries could sputter. And the global economy might wobble.

Such are the more dire predictions if the United States lost its top-notch AAA credit rating, a possibility after the ratings agency Standard & Poor's on Monday revised its outlook for America's credit score due to the lack of action by the government in reducing its budget deficit.

Never before has S&P placed the full faith and credit of the United States on "outlook negative", highlighting the uncertainty.

"While still a remote risk, the possibility of the U.S. losing its AAA rating could result in a wholesale abandonment of dollar assets and would potentially destabilize the entire global economy," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.

When Moody's Investors Service revised its outlook on Japan's AAA-rated sovereign debt to negative from stable in 1998 -- similar to what S&P did to the United States on Monday -- the yen sank to its lowest level in six years and government bond prices fell sharply.

U.S. stock markets fell on Monday and the CBOE volatility index .VIX, better known as Wall Street's fear gauge, surged more than 17 percent at one point. The U.S. dollar, however, gained on the euro, largely on concerns about Europe's debt crisis.

"One of the reasons why the U.S. dollar is still the reserve currency is the lack of other options, and in two years there may still be no other options," said Tom Simons, a money market economist at Jefferies & Co. in New York.

If the dollar did weaken, it could boosts export sales of U.S. manufacturers, but also put upward pressure on inflation by making imports more expensive.

The greater threat might be higher borrowing costs if investors demand a greater reward to take on more risk from a less credit-worthy nation. The knock-on effect would be felt in sectors sensitive to interest rates such as housing and automobile sales, both of which were floored by the Great Recession of 2007-2009.

"The housing market is still very fragile, so any bad news is really felt. A downgrade would be a disaster," said Melissa Cohn, chief executive of the Manhattan Mortgage Co., a leading mortgage initiator in New York.

The sale of new homes, for example, have fallen to just a quarter of their 2005 peak.

A downgrade would be less disastrous for the auto industry, which is riding an improving job market and a pent-up demand from the recession to recovery.

"It could affect the amplitude and speed at which we recover. I'm not prepared to say it would send us into an absolute tailspin," said Alan Baum of Baum & Associates, a market research firm focusing on the automotive industry.

"At this point the credit markets are realizing there is money to be made in the automotive financing area and they are still positive in this regard," he said.

Skeptics downplay the significance of a potential S&P downgrade. Tom Porcelli, chief economist at RBC Capital Markets, found that sovereign yields on four countries that lost AAA status actually fell six basis points on average 12 months after a downgrade.
However, three of those examples -- Spain and Ireland in 2009 and Italy in 1991 -- hardly compare to the United States, and the fourth, Japan in 1998, has yet to see significant economic growth.

Thomas Lawler of Lawler Economic & Housing Consulting is among those who discount S&P's negative outlook, saying he would look at hard data on jobs and income for guidance.

"Who cares what they think? These are the same people who rated (subprime) bonds," Lawler said. "I don't view it as a BFD -- a big financial deal."

(Additional reporting by Gertrude Chavez-Dreyfuss and Emily Flitter)