Debt ceiling: financial world warns Washington to hurry up

Fed Chairman Ben Bernanke warns of a 'self-inflicted' wound, and Wall Street firms see dire consequences, if stalemate over how to raise the US debt ceiling persists.

The financial world is flashing an alert to politicians in Washington: You better stop bickering pretty soon, and reach a deal to raise the federal debt limit.

First came word from Moody's, the credit rating firm, that it might downgrade US Treasury debt from its top tier in the realm of bonds. That was Wednesday.

On Thursday, Federal Reserve Chairman Ben Bernanke, in his semi-annual testimony to Congress, said politicians would impose a "self-inflicted" wound to the economy if a needed hike in the debt limit is held up by political differences.

"I think it would be a calamitous outcome, create a very severe financial shock," Mr. Bernanke said. "A default on those [Treasury] securities would throw the financial system ... potentially into chaos."

The warnings are a preliminary signal that, despite an aura of calm in stock and bond prices, the financial response to continued gridlock on the debt issue could be severe. Precisely because of those severe consequences, both politicians and bankers are saying they expect that some bipartisan deal will be reached before an Aug. 2 deadline.

The federal government has run up against its current $14.3 trillion borrowing limit, set by Congress. If that cap isn't raised by early August, the Treasury warns it will not be able to pay all the nation's bills.

Even a short period of late payments on federal debt, Moody's warned, could have long-lasting repercussions for America's reputation in credit markets. "An actual default, regardless of duration, would fundamentally alter Moody's assessment of the timeliness of future payments," the firm said.

A downgrade would raise interest rates on Treasury bonds. In turn, that would push up rates for mortgages, car loans, and other debts linked to Treasury rates.

Although raising the debt ceiling is the most important move Washington can make to avert a credit downgrade, it's not the only important step. Rating firms including Fitch and Standard & Poor's also want to see Congress make progress – now or in the near future – on mending long-term imbalances in the federal budget. That would mean, most notably, changes to entitlement programs like Medicare, where spending is poised to outstrip tax revenue for years to come.

If the debt ceiling is not raised, one scenario is that the Treasury might be able prioritize its debt payments to creditors, while slowing or stalling other federal programs. But that, too, could have big economic implications. A sudden and steep reduction in federal spending could tip the nation into recession, some forecasters warn.

• Material from the Associated Press was used in this story.