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Moody’s Clashes With Treasury’s Lew on Prioritizing Payments

The U.S. will likely prioritize debt payments ahead of other obligations, should Congress fail to raise the nation’s $16.7 trillion debt ceiling, according to Moody’s Investors Service. Treasury has signaled less optimism on the department’s ability to “pick and choose” payments.

Moody’s, which rates the U.S. a stable Aaa grade, reiterated yesterday that it expects the debt ceiling to be raised, averting a default. The company also expects “that the U.S. government will pay interest and principal on its debt even if the statutory debt limit isn’t raised.” Fitch Ratings and Standard & Poor’s have also said they expect the U.S. to avoid default.

While default may threaten to spark a financial crisis exceeding that seen in 2008, the S&P 500 Index of stocks has traded at an almost one-month high in a bet that Democrats and Republicans will decline to test that outcome. Treasury Secretary Jacob J. Lew said anyone suggesting the U.S. system can be reconfigured to only make some payments doesn’t understand its architecture and that doing so is “default by another name.”

“Any indication from the Treasury that they can prioritize payments takes some of the pressure off Congress,” Guy LeBas, chief fixed income strategist in Philadelphia at Janney Montgomery Scott LLC, said in a phone interview. “If you’re walking a tightrope with a safety net beneath it, you’re more likely to take a greater risk. Part of the administration’s job is giving the appearance that safety net doesn’t exist.”

Payment System

Lew has told Congress extraordinary measures being used to avoid breaching the debt ceiling “will be exhausted no later than Oct. 17” and officials will have about $30 billion in cash to pay obligations.

“I don’t believe there is a way to pick and choose on a broad basis,” Lew said Oct. 10 in testimony to Congress about making debt payments instead of other obligations, such as those to people receiving Social Security benefits or to salaries to soldiers.

“The system was not designed to be turned off selectively,” Lew said. “So anyone who thinks that it can be done just doesn’t know the architecture of our multiple payment systems that are very complex. They were designed properly to pay our bills, they were not designed to not pay our bills.”

Earlier Battle

An administration official during the budget battle in 2011 said Treasury would give priority to paying bondholders if needed. A default may not disrupt markets as long as the U.S. alerted traders the night before a payment was due that it was probably going to default, giving the Federal Reserve’s Fedwire, an electronic service that transfers securities and payments, enough time to adjust its programs and allow the defaulted debt to be “transferable,” according to JPMorgan Chase & Co.

S&P’s AA+ grade for the U.S. already “incorporates the current level of discord” in Washington, John Piecuch, a spokesman for S&P, said yesterday in an e-mail that reiterated the firm’s stance.

“We have not published any opinion on prioritization of payments or other possible courses of action in the event the debt limit is not raised by the time net new financing is needed,” Piecuch said. If “the debt ceiling is not raised by the time net new financing is needed, we expect Treasury to indicate its plans for dealing with this unprecedented turn of events.”

Congressional Negotiations

The U.S.’s AAA grade was placed on rating watch negative by Fitch today. “The political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default,” Fitch said.

Political wrangling “dents confidence in the effectiveness of the U.S. government and political institutions,” the rating company said today in a statement. “It will also have some detrimental effect on the U.S. economy.”

Senate leaders were poised to reach an agreement as early as today to bring a halt to the fiscal standoff, and now must race the clock to sell the plan to lawmakers before U.S. borrowing authority runs out this week.

A deal would stave off a potential default, end the 15-day-old government shutdown and change the immediate deadlines in favor of three new ones over the next four months. It’s far from complete as the Senate may delay passing the plan and House Republicans may seek to block or change it.

S&P Vindicated

S&P stripped the U.S. of its top credit grade on Aug. 5, 2011, citing Washington gridlock and the lack of an agreement on a way to contain its growing ratio of debt to gross domestic product. The ratio of public debt to GDP is projected to decline to 74.6 percent in 2015 after peaking next year at 76.2 percent, according to a Congressional Budget Office forecast in May.

“We do think what’s going on right now validates our decision to lower the rating one notch,” John Chambers, managing director of sovereign ratings at S&P, said today in an interview on Bloomberg Television’s “Surveillance.” “We think there will be an 11th hour deal, and that is our working assumption.”

While the S&P downgrade didn’t result in investors charging the U.S. more to borrow, as 10-year yields slipped to a record 1.38 percent in July 2012, the move contributed to a global stock-market rout that erased about $6 trillion in value from July 26 to Aug. 12, 2011.

Yields on Treasuries (USGG10YR) due in 10 years have increased since then to 2.7 percent.

Debt Load

While Washington wrangles over its finances, the U.S.’s debt load has stabilized for about the next five years, according to the Congressional Budget Office.

Spending cuts totaling $1.2 trillion during nine years, with $85 billion set to take effect in the remaining months of this fiscal year, were triggered in March when the government failed to agree on a way to replace them with other budget reduction measures. The reductions, known as sequestration, were part of the 2011 agreement that lifted the federal debt limit.

“As the similar situation in 2011 demonstrated, partisan disputes also offer the prospect of a shift towards more meaningful policies to contain spending and stabilize the debt trajectory, ultimately supporting sovereign creditworthiness,” Moody’s said Oct. 14 in a report. “The budget deficit has been declining and we expect it to continue to decline over the next few years.”

Reserve Currency

Rates on securities due in October fell from highs reached last week as those maturing in November and December rose on speculation that prolonged negotiations may put those securities at risk of default. The government has been partially shutdown since Sept. 30.

“There isn’t life beyond a default,” Anshu Jain, co-CEO of Deutsche Bank AG, said at a panel discussion at the Institute of International Finance’s annual meeting in Washington on Oct. 12. Deutsche Bank is the world’s biggest currency trader.

“The dollar is a storehouse of value for global wealth. There is an intimate connection between the integrity of U.S. dollar debt and the status of the dollar as the international reserve currency,” Jain said. “You cannot mess with that. You’re now talking about the underpinnings of finance.”

The Bloomberg U.S. Dollar Index, which tracks the greenback against 10 other major currencies, rose 0.1 percent to 1,012.59 after declining 0.2 percent in the past two days.

-- With assistance from Ian Katz in Washington and Sara Eisen, Liz Capo McCormick and Christine Harper in New York. Editors: Dave Liedtka, Gregory Storey

To contact the reporter on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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