This is what happens when you play chicken with the debt limit:
Moody’s Investors Service said today that if there is no progress on increasing the statutory debt limit in coming weeks, it expects to place the US government’s rating under review for possible downgrade, due to the very small but rising risk of a short-lived default. If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody’s to change its outlook to negative on the Aaa rating.
Although Moody’s fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations. The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody’s will place the rating under review.
Moody’s had previously indicated that its stable outlook on the Aaa rating was based on the assumption that meaningful progress would be made within the next eighteen months in adopting measures to reverse the country’s upward debt trajectory. The debt limit negotiations represent a real near-term opportunity for agreement on a plan for fiscal consolidation. If this current opportunity passes, Moody’s believes that the likelihood of anything significant being accomplished before the next presidential election is reduced, in part because the two parties each hopes to capture both a congressional majority and the presidency in the 2012 election, after which the winning party could achieve its own agenda. Therefore, failure to reach an agreement as part of the current negotiations would increase the likelihood of a negative outlook in the near term, because the upward debt trajectory would still be in place. At present, this appears the most likely outcome, in Moody’s opinion.
However, if the debt limit is raised for a short period to allow continued negotiations on a long-term deal, Moody’s might delay any rating action on the rating outlook pending the outcome of those negotiations, assuming that the negotiations appeared likely to accomplish a substantive change in the debt trajectory.
The National Review is already reving up its counterspin to what they say will be the White House’s spin on this development:
The White House will try to spin this as primarily a consequence of default fears resulting from Republican obstinacy in the debt-ceiling debate, but that is not the case: Moody’s expected the debt-ceiling debate to be an opportunity for producing a credible fiscal-reform program. That has not happened, meaning that the debt will probably keep piling up until after November 2012.
Of course, Moody’s does want Congress to come to an agreement on a deficit reduction plan, but this New York Times article by Jackie Holmes makes it very clear that the immediate priority is to raise the debt ceiling (emphasis is mine):
Moody’s warning was two-pronged. First, it said, if Congress does not raise the $14.3 trillion debt in coming weeks, the nation’s credit rating could be lowered “due to the very small but rising risk of a short-lived default.” That would likely translate into higher interest rates at a time when the recovery is again slowing.
And second, Moody’s warned with an implicit slap at both parties, whether the United States keeps that triple-A rating “will depend on the outcome of negotiations on deficit reduction.”
The WaPo‘s Jonathan Capehart suggests we start praying, because the real Rapture is upon us.