Moody’s hints at move that could be catastrophic for US debt

The US needs to make significant government spending cuts or else risk losing its gold-plated credit rating that has made extensive borrowing so affordable, Moody’s Investor Service said late Monday.

The announcement was a sobering warning that the country’s burgeoning debt has weakened the country’s economic standing, and that US Treasury Bonds, traditionally a bullet-proof investment, could lose their sterling Aaa-rating if Washington cannot control its federal debt.

If Moody’s were to downgrade the country’s rating, the impact could be severe. It would signal to lenders worldwide that the US is no longer one of the safest places to invest money.

That, in turn, would threaten the country’s ability to borrow freely and extensively from other countries on favorable terms. Investors would likely demand a higher interest rate to finance US debt, which would push federal debt higher still.

“There’s a profound effect in this announcement,” says Max Fraad Wolff, a professor of economics at New School University in New York. “The US has always been the gold standard … and this begins to signal a fall or weakness in US global economic position. That’s a bit like a sea change.”

For now, a warning

Moody’s, one of three research and ratings firms that monitor issuers of stocks and bonds, clearly indicated its announcement was a warning, and that it would not downgrade the US’s rating soon.

“The ratings of all Aaa governments are currently well positioned despite their stretched finances,” Moody’s quarterly Sovereign Monitor reported.

Although it hasn’t yet taken any action to downgrade US ratings, Moody’s announcement will likely rattle investors and decrease investor confidence in US bonds.

“The ratings agencies are telling people, ‘This country is not in good shape, be careful investors,’” says Mr. Wolff, who is also senior economist for Beryl Consulting Group LLC.

Credit ratings are based upon the safety and success of a country’s economy and indicate to lenders how likely a borrower, like the US government, is to pay back a loan.

Ultimately, a downgraded rating would make borrowing more expensive and threaten the US’s ability to keep spending far more than it takes in from tax revenue, a risk the country can ill afford as it plans to ratchet up spending on everything from unemployment benefits to healthcare to Social Security.

“If markets perceive US federal debt as more dangerous, the cost of borrowing money rises,” says Wolff. “The federal government presently owes $10.5 trillion. If the cost of borrowing rises, it’s a particularly big deal if you owe a lot of money, like US government.”

It would also exacerbate the US’s current debt, said Pierre Cailleteau, Managing 
Director of Moody's Sovereign Risk Group.

"At the current elevated levels of debt, rising interest rates could quickly compound an already complicated debt equation, with more abrupt rating consequences a possibility," Mr. Cailleteau said in the report.

In it’s report, Moody’s said debt levels in the US were to blame for its threatened economic standing.

“This is a signal to the US government: don’t keep spending like this, we are displeased with it," says Wolff.

A global concern

Similar problems in Europe have triggered this announcement, Wolff adds. “Problems in Portugal, Ireland, Italy, and Greece, have reawakened questions about the quality of sovereign debt,” he says.

The Obama administration estimates US deficit (the difference between how much money a government takes in and how much it spends) will rise to 10.6 percent of GDP this year, the highest level since 1946. Federal debt (money the government owes lenders) will likely reach 64 percent of GDP.

The US can straighten up its balance sheet – for example, raising taxes and cutting spending – to stave off a downgrade, says Moody’s.

“A key issue is whether governments are able and willing to implement such unprecedented adjustments,” said Mr. Cailleteau, in a statement.