Sept. 22 (Bloomberg) -- As Uncle Sam transmogrifies into Hedge-Fund Guy, gorging on debt to buy $700 billion of toxic assets to keep the financial system afloat, the U.S. government's AAA status has to be deemed unsafe. It just has to.

In any possible universe, that grade becomes questionable once the U.S. financial situation changes as radically as it has in recent weeks. So far, though, it isn't even under review by the rating companies.

That's a mistake. As flawed as Moody's Investors Service, Standard & Poor's and Fitch Ratings are, there is no way they would allow a company to undergo the philosophical, financial and ethical contortions that the U.S. has endured without a re- evaluation of creditworthiness.

The U.S. is fast becoming the world's biggest sovereign wealth fund. It owns a couple of mortgage lenders in Fannie Mae and Freddie Mac; it controls American International Group Inc., which turned out to be a dodgy derivatives shop that dabbled in insurance; and it has a $29 billion stake in brokerage firm Bear Stearns Cos., the adopted wild-child of JPMorgan Chase & Co.

Now, the U.S. plans to set up a special fund to buy the distressed assets that the finance industry loaded up on when hubris was still in fashion. Those securities turned out to be pure poison as soon as anyone bothered to look inside the derivatives boxes to see what they were really made of.

Fund Diversification

All that the U.S. needs to complete its portfolio is a manufacturing company -- and either Ford Motor Co. or General Motors Corp. (or both) might just fit the bill if consumers don't end their un-American refusal to update the model parked in their driveway just because the economic horizon is a little hazy.

Treasury Secretary Henry Paulson is asking Congress to let him spend the equivalent of the combined annual U.S. budgets for defense, education and health. He needs to raise the national debt ceiling to $11.315 trillion from $10.615 trillion for the plan to work.

A trillion here and a trillion there should finally persuade the bond raters to discover sufficient backbone to question the U.S.'s financial health. Their spines, however, haven't been much in evidence in recent years, and with the threat of increased regulation of rating companies for their part in the financial debacle looming large, they may again chicken out.

`Actual Risks'

``The profile is now weaker because contingent risks have become actual risks,'' John Chambers, managing director of sovereign ratings at S&P in New York, said last week as he affirmed that the U.S. rating outlook was still stable. Moody's spokesman John Cline said the rating is ``still safely Aaa.''

Investors are less relaxed. The 10-year credit default swap on U.S. Treasuries climbed as high as 28 basis points last week, almost triple where it traded in April and up from just 2 basis points at the beginning of the year.

To make money, traders don't need the U.S. to actually default; they just need their peers to grow concerned about the creditworthiness of Treasuries, which is what drives the swap price higher. The contracts on U.S. debt are priced in euros, meaning it now costs 28,000 euros ($41,000) per year to insure 10 million euros of Treasuries against default for 10 years.

As bailouts become fashionable, other sovereign borrowers are also deemed riskier than they were. The equivalent default- swap contract on U.K. government securities reached 32 basis points last week, a jump of 8 basis points in two weeks. Buying 10-year protection on Spain now costs about 52 basis points, up from 35 basis points in May, while Irish debt cover has climbed to 42 basis points from 22 basis points in March.

Buyer of Last Resort

Just as the U.S. has decided to nationalize its mortgage industry by becoming the buyer of last resort for repackaged home loans, investors are wondering whether other countries whose housing markets are in freefall will do the same.

Even though Bank of England Governor Mervyn King has voiced his opposition to risking taxpayer money in this way, for example, Prime Minister Gordon Brown might order his central bank to begin accepting freshly minted mortgages in return for shiny, gilt-edged government debt.

Lenders would be more willing to make loans, safe in the knowledge they could recycle them via the central bank and redistribute the risk. A housing-market rescue is a pretty tempting prospect for a beleaguered government staring down the barrel of a recession.

Remember the neutron bomb, designed to annihilate entire populations while leaving all of the buildings intact? Government bailout plans are likely to achieve the exact opposite; millions of orphans and widows will remain undamaged, their money-market savings and insurance policies and home loans indemnified by the government, while the financial institutions and systems created in the past century crumble to dust.

``When I picked up my newspaper yesterday, I thought I woke up in France,'' Senator Jim Bunning, a Republican from Kentucky, said in July in response to U.S. efforts then to keep Fannie and Freddie alive. How does Bunning feel now that he's living in the People's Republic of Paulson?

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Mark Gilbert in London at magilbert@bloomberg.net

Last Updated: September 22, 2008 04:35 EDT