Britain Warned On Credit Rating

By Annys Shin
Washington Post Staff Writer
Friday, May 22, 2009

A leading credit rating agency cut its outlook for Britain yesterday, moving the country a step closer to a downgrade and highlighting the vulnerability of the United States' own top-notch rating.

In cutting its outlook for Britain's sovereign rating from stable to negative for the first time, Standard & Poor's cited debt levels approaching the size of the nation's gross domestic product. While S&P reaffirmed Britain's actual long-term credit rating at AAA, its statement was effectively a warning about massive government spending.

Soaring budget deficits in Britain and the United States have set off alarm bells at credit rating agencies such as S&P, Moody's Investors Service and Fitch, which assign grades to different types of debt. The grades -- ranging from C, or junk-bond status, to triple-A -- gauge the risk that a company or a country might default on its debts. A nation's rating is known as a sovereign rating.

A sovereign rating downgrade can undermine investor confidence at a time when many governments need investors to buy their debt. That could make it more costly to finance bank bailouts or stimulus spending.

The lowering of the outlook for Britain serves as a cautionary note for the United States, analysts said, because the federal government is also running record deficits as it tries to revive the economy.

"Contracting economic activity does really adverse things to government revenues, and so unless you're a magician your deficits get worse," said Carmen Reinhart, a University of Maryland economist. "And if your deficits get worse, you finance it with debt. . . . Debt leads to downgrades."

Since the recession began in December 2007, the rating agencies have warned of potential threats to the U.S. rating, including the government bailout of mortgage finance companies Fannie Mae and Freddie Mac. In September, after the first bailout of American International Group, S&P Managing Director John Chambers likened the U.S. triple-A rating to a live lobster in a pot of water with a fast-rising temperature. He told Reuters: "There's no God-given gift of an 'AAA' rating, and the U.S. has to earn it like everyone else."

A growing number of countries have had their sovereign ratings tarnished. Since January, Ireland lost its AAA rating with S&P, India's credit outlook was downgraded to negative from stable and Latvia's debt is at junk status. Iceland lost its triple-A rating last year, and Spain, Portugal and Greece have had their ratings taken down a notch.

The United States has stayed out of that club, and actually had its rating reaffirmed by S&P in January. Many analysts argue that the odds of a downgrade are remote for several reasons. The U.S. government can print money to finance debt. The dollar is a global reserve currency, which helps sustain demand for U.S. debt securities. And according to S&P, even in a worst-case scenario, the size of the government's debt in relation to the GDP would still be in line with that of triple-A countries such as Germany and France.

To stave off a downgrade, leaders on both sides of the Atlantic have worked hard to convince the rating agencies of their commitment to fiscal responsibility.

The Obama administration and Federal Reserve are attempting to walk a fine line on spending. To combat the recession, they created a number of programs with multibillion-dollar price tags. But as the downturn has shown signs of slowing, they have started to emphasize their commitment to deficit busting.

"We must get our fiscal house in order or risk having government borrowing crowd out productive private investment," Treasury Secretary Timothy F. Geithner said at a congressional hearing yesterday. "Treasury and the White House will work with Congress to make the tax changes that are necessary to reduce deficits and do so in a manner that is fair to all Americans."

© 2009 The Washington Post Company