June 3, 2011

Moody’s Warns of U.S. Downgrade Over Debt Ceiling, Risk of Default

Ratings agency worried over tenor of debt-ceiling argument in Washington, risk of short-term default

As Congress and the Obama Administration continue to spar over how to reduce the long-term debt of the country, and whether to raise the debt ceiling, a major credit rating agency has warned that it may downgrade the credit of the United States of America.

Moody’s warned Thursday that “if there is no progress on increasing the statutory debt limit in coming weeks, it expects to place the U.S. government's rating under review for possible downgrade, due to the very small but rising risk of a short-lived default.”

Moody’s continued in its warning: “If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody's to change its outlook to negative on the Aaa rating.”

Though Moody’s said in its report that it, “anticipates that a default would be cured quickly,” the rating agency left open the door to a potential downgrade of the U.S. to “a rating in the Aa range.” 

The Potential Repercussions

While those who argue against raising the U.S. debt limit cite a desire to cut spending now as a way to cut the long-term U.S. deficit, many economists and Administration officials argue that even a hint of the threat of default by the world’s go-to haven in any crisis—U.S. sovereign debt—could have serious consequences for the fiscal health of the nation.

Treasury securities pay a relatively low interest rate in return for offering investors a place to park their money, knowing with certainty that the full faith and credit of the United States, and its taxing power, stands behind these securities. If the U.S. defaults, even temporarily, it will still have to borrow to fund obligations. But if there is uncertainty about America’s willingness to pay off its securities, it will have to pay higher interest rates on that debt, which might raise the need for higher taxes.

Referring to the risk of a credit downgrade and default, U.S. Deputy Treasury Secretary Neal Wolin said in mid-May that “this is not something we can afford to let happen or to let people think might happen,” adding, “We are talking about a unique and fragile asset of the U.S.: the full faith and credit idea.” 

S&P Also Wary of U.S. Debt

On April 18, S&P affirmed its AAA/A1+  rating on the United States of America, but announced its “outlook” on the U.S. is “Negative,” stating, “We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns.”

Meanwhile, the Treasury Department has used its trading prowess to stave off hitting the debt ceiling, and Treasury Secretary Timothy Geithner has publicly stated that Congress will come around and extend the debt ceiling, but the open question remains on how much damage will be done in the perceived creditworthiness of the United States and if that damage will be lasting, potentially costing taxpayers more and not less for America’s Treasury debt.

The White House has been meeting with Congressional members over the debt limit, and reportedly has been imploring rating agencies to maintain America’s pristine rating.

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