Here's how the U.S. could lose its AAA credit rating

03/15/2010 12:44 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The good news, according to Moody’s, is that the U.S. government will spend about 7% of its total revenue in 2010 servicing the huge U.S. debt. That will rise to 11% of total revenue in 2013.

That’s the good news?

Well, sure. Moody’s, one of the three major debt rating companies in the United States, says that if the economy grows 0.5 percentage points more slowly than its baseline forecast of moderate growth, if the government doesn’t cut spending as much as it now thinks likely, and if interest rates climb faster than expected U.S. spending on debt service (that’s the interest the government pays on its debt) could climb to 15% of government revenue.

And that would be bad news indeed because it would probably cost the United States its AAA credit rating. And that would push U.S. interest rates yet higher and economic growth lower.

Here’s how Moody’s will do the math to determine if the United States should lose its AAA rating.

If an AAA-rated country spends more than 10% of its revenue on servicing its debt, Moody’s doesn’t downgrade it immediately. The country gets a bit of time to get its fiscal act together. That time amounts to what Moody’s calls a “debt reversibility band.” The size of that band depends on Moody’s assessment of how willing and likely a country is to reduce the size of its debt. For the United States Moody’s has set a 4 percentage point band.

Which is why the possibility that lower growth, fewer spending cuts, and higher interest rates could push debt service about 15% of total revenue is so scary.

Last time I did the math 15% was more than 10% plus 4%. And that would probably earn the United States a downgrade from AAA.

The United States doesn’t have to start cutting spending immediately. That’s fortunate because immediate spending cuts could stall this still very fragile recovery.

But the window isn’t very large—less than three years—and it gets narrower every day.

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