Moody's Warns U.S. - Deal with Debt Ceiling
By:NewsyStocks   Friday, June 03, 2011 10:37 AM

Moody's Investor Services gave the president and congressional leaders an unambiguous message yesterday – deal with the debt ceiling or risk the federal government's credit rating. The agency also said the federal credit rating also depends upon a "credible agreement on substantial deficit reduction."

The ratings agency admitted the risk of the federal government suffering a short-term loan default is small, but that risk is rising. If the debt limit is raised and a default avoided, then Moody's will maintain its Aaa rating on U.S. government debt.

But there was a stern warning contained in the Moody's announcement. If political leaders can't cut the deficit, they can't assume a continued high debt rating. In addition, Moody's said that entrenched positions and political posturing increase the chances of a short-term default.

"The debt limit negotiations represent a real near-term opportunity for agreement on a plan for fiscal consolidation," the organization said in a press release. "If this current opportunity passes, Moody's believes that the likelihood of anything significant being accomplished before the next presidential election is reduced, in part because the two parties each hopes to capture both a congressional majority and the presidency in the 2012 election, after which the winning party could achieve its own agenda."

However, if the debt limit is raised for a short period to allow continued negotiations on a long-term deal, Moody's might delay any rating action on the rating outlook pending the outcome of those negotiations, assuming that the negotiations appeared likely to accomplish a substantive change in the debt trajectory.

These developments have the following rating implications.

1) The likelihood that Moody's will place the US government's rating on review for downgrade due to the risk of a short-lived default has increased. Since the risk of continuing stalemate has grown, if progress in negotiations is not evident by the middle of July, such a rating action is likely. The Secretary of the Treasury has indicated that the government will have to drastically reduce expenditure sometime around August 2 if the debt limit is not raised; the initiation of a rating review would precede this date.

2) If a debt-ceiling-related default were to occur, Moody's would likely downgrade the rating shortly thereafter. The extent of and length of time before a downgrade would depend on how factors surrounding the default affect the government's fundamental creditworthiness, including (a) the speed at which the default were cured, (b) an assessment of the effect of the default on long-term Treasury borrowing costs, and (c) measures put in place to prevent a recurrence. However, a rating in the Aa range would be the most likely outcome. Any loss to bondholders would likely be minimal or non-existent, as Moody's anticipates that a default would be cured quickly.

3) If default is avoided, the Aaa rating would likely be affirmed after any review. Whether the outlook on the rating would be stable or negative would depend upon whether the outcome of the negotiations included meaningful progress toward substantial and credible long-term deficit reduction. Such reduction would imply stabilization within a few years and ultimately a decline in the government's debt ratios, including the ratio of debt to GDP.