Committee for a Responsible Federal Budget

Moody's Issues Warning on Debt Ceiling

Jun 3, 2011

We can't just seem to catch a break from ratings firms. About a month and a half after S&P downgraded the U.S. rating outlook from stable to negative, Moody's is warning the U.S. that it will definitely review and possibly downgrade our debt if we fail to raise the debt ceiling.

According to Moody's, "the degree of entrenchment into conflicting positions has exceeded expectations," which has put debt-limit-related default on their radar. They say that assuming the August 2 date still holds in a few months, Moody's will put the US rating on review by mid-July. So, for those who see no problem waiting until the last minute to raise the debt ceiling, the damage might be done before then if Moody's decides to downgrade the US. 

As Moody's further explains:

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.

But the short-term warning is just one part of Moody's update. They also warn that a downgrade to a negative outlook, like S&P already did, is likely if the we do not change our current debt trajectory.

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. Therefore, failure to reach an agreement as part of the current negotiations would increase the likelihood of a negative outlook in the near term, because the upward debt trajectory would still be in place.

This warning shows the conundrum we face in raising the debt ceiling. Obviously, being downgraded to Aa in the event of lawmakers failing to raise the debt ceiling on time would be more severe than being downgraded to a negative outlook due to our unsustainable path. But, as Moody's says, this may represent the best "near term opportunity" to get a handle on our debt path. The message is clear: the country needs a comprehensive fiscal plan.

Click here to read our ideas on responsible approaches to raising the debt limit.