Moody's May Downgrade U.S. Debt, If Crisis Isn't Resolved

Analysis

Moody's Investors Service has placed the Aaa bond rating of the U.S. Government on review for a possible downgrade, due to the debt deal talks stalemate in Washington, and the possibility of a U.S. debt default, the credit rating agency announced Thursday.

The threat rachets-up the pressure on President Barack Obama, D-Ill., and Congressional Republicans to reach an agreement on how to cut the budget deficit and simultaneously raise the debt ceiling.

If no agreement is reached and Moody's downgrades U.S. debt, it would be the nation's first downgrade since 1917. The U.S. was also put on review in 1995, during the last, serious budget stalemate, when Congressional Republicans shut down the federal government, due to a budget impasse with then President Bill Clinton, D-Arkansas.

Moody' s is concerned that the debt threshold won't be raised in time to prevent a missed interest or principal payment on outstanding U.S bonds and notes. The U.S. rating may be reduced to Aa range.

Congressional Republicans and President Obama are at loggerheads over how to cut the budget deficit as part of a package to raise the nation's debt ceiling.

Republicans argue that Congress should substantially cut government spending to cut the budget deficit. Meanwhile, Democrats insist that revenue increases must be a part of the talks for any meaningful and enduring deficit reduction to occur.

Also on Wednesday, U.S. Federal Reserve Chairman Ben Bernanke, in his regular, semi-annual testimony on the U.S. economy on Capitol Hill, underscored that a default would trigger a huge financial calamity, adding that it would send a financial shockwave throughout the global financial system.

Bernanke said U.S. Government bonds are considered the lowest-risk bond investment class in the world, and serve as a benchmark for interest rates for other, more-risky bond and asset classes. If investors can't count on the safety of U.S. debt, they would ask for higher interest on that asset class, pushing up the interest rates on other assets, among other ripple effects, he said.

On Aug. 4, the U.S. Treasury Department is due to pay off $30 billion in maturing short-term debt. In theory, the United States could prioritize debt payments, but U.S. Treasury Secretary Timothy Geithner warned lawmakers in Congress that the prioritization tactic would still cause investors to shun U.S. Treasury securities, commonly known as Treasuries.

Geithner has also repeatedly took pains to point out that failing to raise the debt ceiling will have no constructive outcomes for the nation's fiscal condition, the task of deficit reduction, and U.S. and global stock and bond markets.

On Wednesday, a 'ray of light' in the debt talks emerged when Senate Minortity Leader Mitch McConnell, R-Ky., presented a plan in which Congress would shift the debt ceiling raise power via a negative vote in the Congress, which could be then be vetoed by President Obama, with the bill stipulating that the veto of which would require the debt ceiling to be raised. This, McConnell said, in so many words, would give conservative Republicans the 'poltical cover' needed on the issue -- i.e. technically not being seen as raising the debt ceiling. Proceedurally, the Repubicans will have been recorded as voting no on the debt ceiling.

McConnell also said the bill would enable the president to raise the debt ceiling without guaranteed spending cuts; therefore, it would resolve the primary problem facing Congress: preventing a U.S. government default.

However, Congressional Republican criticism of the plan was swift and direct. House Minority Leader Eric Cantor, R-Va., rejected McConnell's plan, vowing to press ahead with conservtive Republicans' primary goal: cutting government spending substantially.

Currently, there is not a single debt limit proposal that can pass the House of Representatives, Cantor said in a statement released just before top lawmakers from both parties resumed afternoon negotiations at the White House.

Political/Public Policy Analysis: Put the risk of a U.S. Government default, on a scale of 0 to 100, at 45%. Both sides need to end the rhetoric, come to their senses, and raise the debt ceiing, now, while also creating a 10-year outine for deficit deduction comprised primarily of spending cuts.