- Fannie Mae, Freddie Mac, FHLBs.
- Liabilities guaranteed by the FDIC.
- Some pre-funded municipal bonds.
- Federal lease transactions.
- Certain structured finance deals.
- Some Israeli government bonds.
- One Egyptian government bond.
- …
The list comes to us from Moody’s, which looks at the possible ratings impact of a US sovereign downgrade in Monday’s structured finance quick check. Now the credit rating agency has said before that it will place the US government’s triple-A rating on review for downgrade if there’s no “demonstrable progress” on the debt ceiling talks. Unsurprisingly, a downgrade of the US would have a ripple effect on a number of other assets which are directly linked to the fortunes of the States.
Let’s get the quirky stuff out of the way first. The Israeli bonds, we think, are USAID bonds issued by the State of Israel in the early 2000s and fully guaranteed by the USA. The Egyptian bond is another US-guaranteed issue apparently done earlier this year in an effort to plug Egypt’s budget gap after the spring uprising.
Bizarre yes, but kind of predictable. These are direct linkages.
Look, for instance, at structured finance transactions composed of government-guaranteed student loans, or Residential Mortgage-Backed Securities (RMBS) backed by the GSEs. Look too, at deals which are defeased by US Treasury strips (that is, when US debt is set aside specifically to service the debt).
Or look at structured finance deals which are predicated on certain swap counterparties — i.e banks.
Banks don’t appear on the list above, but they are specifically mentioned in the Moody’s report as things which might also be impacted by a US downgrade, given that the agency (still) factors in a degree of government support into their ratings. They also mention “indirect linkages” which could allow a US downgrade to trickle down to domestic American companies. Nowadays plenty of firms are rated above their respective countries’ of domicile, but it doesn’t mean they’ve completely decoupled.
As Moody’s reminds us:
The importance of these indirect credit linkages is supported by empirical evidence that when sovereigns default, the default rates of their domestic corporates, banks, and local and regional governments also spike upward. As a result of these indirect credit linkages, it is unusual for a fundamental issuer to be rated more than one or two rating notches above the sovereign’s rating. Accordingly, the credit linkages between the sovereign and other domestic issuers will likely be greater as the sovereign’s rating declines, to a degree that will depend on the magnitude of the issuer’s exposure to the macroeconomy, federal taxation, the revision of government services, the domestic banking system and foreign exchange rates. As a result of these indirect credit linkages, it is unusual for a fundamental issuer to be rated more than one or two rating notches above the sovereign’s rating.
So any list including indirect links could end up being rather longer.
Related links:
What price an AAA downgrade? - FT Alphaville
Triple-A utility, Aa3 country - FT Alphaville