U.S. Default Would Change Fundamentals of Rating, Moody’s Says

The U.S. would risk not winning back its top Aaa credit rating soon if a failure by Congress to raise the nation’s debt limit causes even a short-term default, according to Moody’s Investors Service’s senior credit officer.

“Up until now, our assumption was that the risk is virtually zero of them ever missing an interest payment,” Moody’s Steven Hess said during an interview. “If they actually miss a debt payment, then it’s a fundamental change.”

Republicans are using talks to increase the $14.3 trillion debt-ceiling to press for cuts in spending. Negotiators seeking a bipartisan plan to reduce federal deficits said they oppose pairing it with only a short-term boost in the U.S. debt limit that the Treasury Department estimates will be breached at the start of August. Moody’s warned on June 2 that it will put the credit rating under review for a downgrade unless there’s progress on increasing the debt limit by mid-July.

A default stemming from “the debt limit and the political configuration would indicate that, well, this might happen again,” Hess said at Bloomberg headquarters in New York on June 21. “That risk is perhaps not compatible with Aaa.”

Traders are demanding higher prices to insure Treasuries against default as the standoff between Congress and the Obama administration drags on.

‘Catastrophic Effects’

The costs for insuring against default for one year have risen to 49.5 basis points as of June 21 from 24 basis points on May 16, when the U.S. reached its borrowing limit, according to index administrator Markit Group Ltd. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

Treasury Secretary Timothy F. Geithner has warned that a failure to raise the debt ceiling may have catastrophic effects on the U.S. economy by sharply raising borrowing costs. At the same time, yields on Treasuries remain close to the lows of the year as the economy shows signs of slowing and investors seek a refuge from Europe’s sovereign-debt crisis.

Yields on benchmark 10-year notes were little changed yesterday at 2.99 percent. That’s down from the average of about 4.08 percent over the past decade.

The U.S. rating could be raised to Aaa again after a short-lived default “if, No. 1, they reached an agreement that addressed the debt trajectory, and No. 2, they did something to fix the institutional arrangement around the debt limit so that you would be confident that it would not happen again,” Hess said. “Those things are not going to happen overnight.”

Debt to GDP

Moody’s may still assign a negative outlook within a few months if the government fails to agree on a plan that would begin reducing its debt ratio to gross domestic product in three to four years, Hess said.

U.S. debt was 58.9 percent of GDP as of Dec. 31. The Congressional Budget Office estimated in March that U.S. deficit spending will push that figure to 90 percent by 2017, a level that economists Kenneth Rogoff and Carmen Reinhart say can weigh on long-term growth prospects.

Standard & Poor’s put the U.S. government on notice in April that it risks losing its top AAA rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt. The Obama administration projects that the deficit will climb to $1.6 trillion in the current fiscal year.

“We’re looking for some agreement that shows the deficit path with lower deficits and eventually producing a trajectory of debt-to-GDP level that goes down,” Hess said. “Because 2012 is the presidential election year, if they don’t have one soon they’re probably not going to have one until 2013 at the earliest, and we think that’s a little too long to wait.”

Publicly held federal debt will reach roughly 70 percent of the nation’s gross domestic product by the end of this year, the highest since just after World War II, according to the CBO.

It’s likely to go past 100 percent by 2021 if lawmakers don’t change current policy, the non-partisan agency said in a report updating its long-term budget outlook. The debt will approach 190 percent by 2035, dwarfing the 109 percent set during World War II, the report said.

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