Exclusive: S&P to deeply cut U.S. ratings if debt payment missed

By Walter Brandimarte

NEW YORK (Reuters) - The United States would immediately have its top-notch credit rating slashed to "selective default" if it misses a debt payment on August 4, Standard & Poor's managing director John Chambers told Reuters.

Chambers, who is also the chairman of S&P's sovereign ratings committee, said on Tuesday that U.S. Treasury bills maturing on August 4 would be rated 'D' if the government fails to honor them. Unaffected Treasuries would be downgraded as well, but not as sharply, he said.

"If the U.S. government misses a payment, it goes to D," Chambers said. "That would happen right after August 4, when the bills mature, because they don't have a grace period."

Fears of a technical default have been rising after budget negotiations between Democrats and Republicans fell apart in Washington earlier this week. Even a brief default by the United States would immediately increase the country's borrowing costs, weighing on the fragile economic recovery and eroding the dollar's status as a reserve currency.

On August 4, the Treasury Department is due to pay off $30 billion in maturing short-term debt.

With the debt talks stalled, new ideas are surfacing such as prioritizing debt payments. But Treasury Secretary Timothy Geithner warned lawmakers on Wednesday that such a move would still cause investors to shun Treasury securities.

Geithner said that because the United States now borrows roughly 40 cents of every dollar it spends, prioritizing payments with no debt limit increase would require cutting 40 percent of all government expenditures.

S&P is not the first agency to say it will downgrade the United States if a payment is missed. Rival credit rater Moody's on June 2 was the first to say it would downgrade the United States shortly after a possible ceiling-related default to the Aa range.

Moody's on Wednesday said a U.S. credit downgrade would also affect the ratings of some states and municipalities with strong credit links to the federal government.

Chambers insisted that the likelihood of a U.S. default is "extremely low," as S&P expects a last-minute increase to the country's debt ceiling just like it has happened more than 70 times since the 1960s.

He also noted a default on U.S. Treasuries -- a benchmark against which all other debt is measured -- would dwarf any worries about U.S. credit ratings as global markets would crumble.

Chambers made clear, however, that S&P is more worried about the ability of the government to meaningfully cut its deficit over the next two years, with presidential elections in 2012 making a bipartisan agreement much tougher.

S&P is so far the only of the big-three credit ratings agencies to revise the outlook on the U.S. AAA credit rating to negative. It has said it sees a one-in-three chance of a downgrade within the next two years.

Moody's Investors Service and Fitch Ratings have expressed concern about the pace of budget negotiations in Washington, but still maintain a stable outlook on U.S. ratings.

Yet they have been more vocal about the risks of a "technical default" in August. Fitch said earlier this month it would cut U.S. issuer ratings to "restricted default" if the government misses a more substantial debt payment on August 15.

The Treasury reached the country's $14.3 trillion debt limit on May 16 and has been making use of extraordinary measures to keep servicing its debt since then. It will run out of alternatives to avoid a default on August 2, Geithner has said.

(Editing by Carol Bishopric)