Moody's Puts U.S. on Review for Downgrade

The U.S. inched a step closer on Wednesday to having its coveted AAA rating lowered. Moody's Investors Service said it placed the governments AAA bond rating on review for possible downgrade.

The credit rating firm said it based its decision on the increasing likelihood that the U.S. could default on its debt obligations if Congress fails to reach an agreement to raise the U.S. debt limit before an Aug. 2 deadline set by the Obama Administration.

The review of the US governments bond rating is prompted by the possibility that the debt limit will not be raised in time to prevent a missed payment of interest or principal on outstanding bonds and notes. As such, there is a small but rising risk of a short-lived default, Moodys said in a statement.

Moreover, Moodys warned that its looking for a long-term solution to U.S. debt woes. Once its review is completed, any new potential rating will depend on whether a substantial and credible agreement is achieved on a budget that includes long-term deficit reduction.

The review and possible downgrade warning didnt come entirely by surprise. In June Moody's said a rating review was likely unless meaningful progress had been made in negotiations to raise the debt ceiling. Apparently, they feel meaningful progress has not been made.

Congress has been battling for weeks over an agreement to raise the debt ceiling. Both parties have said no agreement can be reached without an accompanying plan to reduce the massive U.S. national debt, but the two sides cant agree on how best to accomplish that. The announcement has a domino effect that ripples throughout the global economy. Thats because Moody's also placed on review for possible downgrade the AAA ratings of financial institutions directly linked to the U.S. government: they include mortgage giants and quasi government entities Fannie Mae and Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks.

In addition, Moodys said it is reviewing certain housing bonds guaranteed by the government; various municipal ratings directly linked to the U.S. rating. Also, bonds issued by the governments of Israel and Egypt that are guaranteed by the U.S. Moodys said the likelihood of a default on interest payments remains low, but is no longer out of the question. Hence the review.

An actual default, regardless of duration, would fundamentally alter Moody's assessment of the timeliness of future payments, and a Aaa rating would likely no longer be appropriate, the ratings firm said in its statement. Moodys said any default would likely be brief and minimal in its impact to borrowers. Therefore the downgrade would likely be to AA rating.

But if an agreement is reached and default avoided, the AAA rating would likely be confirmed, Moodys said. Moodys said in its statement that it doesnt care how the deficit is reduced as long as a plan is put in place to do it. The Treasury Department responded to Moodys announcement: Moodys assessment is a timely reminder of the need for Congress to move quickly to avoid defaulting on the country's obligations and agree upon a substantial deficit reduction package.

A spokesman for House Speaker John Boehner, (R-Ohio), issued the following statement: As Speaker Boehner has warned for months, if the White House does not take action soon to address our nations debt crisis by reining in spending, the markets may do it for us. This action by Moodys today reinforces the Speakers warning.