Moody's Warns of US Debt Downgrade

Major credit rating agency Moody's warned today that it may downgrade the U.S. credit rating if the government fails to figure out a way to avoid the so-called fiscal cliff at the end of the year.

Credit rating agencies last year issued similar warnings when Congress and the White House were wrangling over the U.S. debt ceiling. While Moody's did not downgrade the U.S. at the time, S&P, another of the big three agencies, downgraded the U.S. from AAA to AA+.

Despite their dubious role in the global financial crisis, credit rating agencies have an impact on the interest rates governments and businesses pay on their debt. Lower ratings mean the government may have to pay higher interest rates on some of its $16 trillion in debt outstanding.

The fiscal cliff is what economists are calling the year-end expiration of the Bush-era tax cuts, plus tax increases and spending cuts that will automatically take place as part of a deal to raise the debt ceiling.


Update of the Outlook for the US Government's Debt Rating

The US government bond rating remains unchanged at Aaa with a negative outlook. The direction of the US rating and its outlook will most likely be determined by the outcome of budget negotiations during the course of 2013. In particular:

» If those negotiations lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable.

» If those negotiations fail to produce a plan that includes such policies, we would expect to lower the rating, probably to Aa1.

» The maintenance of the Aaa with a negative outlook into 2014 is highly unlikely unless the method adopted to achieve debt stabilization involved a large, immediate fiscal shock with a resulting unstable economic situation. Such a shock could come from the so-called "fiscal cliff." In such circumstances, we would await evidence that the economy could rebound from the shock before considering a return to a stable outlook.

It is difficult to predict when during 2013 Congress will conclude negotiations that result in a budget package. The Aaa rating, with its negative outlook, is likely to be maintained until the outcome of those negotiations becomes clear.

It is also worth noting that maintaining the rating outlook assumes a relatively orderly process for the increase in the statutory debt limit. The debt limit will likely be reached around the end of this year, and the government's ability to meet interest and other expenses out of available resources would likely be exhausted within a few months. Under these circumstances, the government's rating would likely be placed under review after the debt limit is reached but several weeks before the exhaustion of the Treasury's resources. Moody's took a similar action during the summer of 2011 after the debt limit had been reached.