The United States could lose its top notch credit rating and that has made its largest creditor, China, nervous.
Standard & Poor's has warned U.S. lawmakers privately that it would downgrade the country's debt if the Treasury Department is forced to prioritize payments because Congress does not raise the debt limit, a congressional aide said Thursday.
That warning came on the heels of an announcement from Moody's on Wednesday that it too would slash the U.S. credit rating in the next few weeks if lawmakers fail to reach a deal.
"The review of the U.S. government's 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," Moody's said in a statement. "As such, there is a small but rising risk of a short-lived default."
China, the U.S.' largest creditor, also expressed grave concern that the U.S. would default on its debt, even briefly. "We hope that the U.S. government adopts responsible policies and measures to guarantee the interests of investors," foreign ministry spokesman Hong Lei said at a regular news briefing in Beijing, when asked about the Moody's report. He did not elaborate.
Moody's was the first among the big-three rating agencies to place the United States' Aaa rating on review for a possible downgrade, which means a negative rating action is impending.
Moody's said it considers the probability of a default on interest payments to be low "but no longer to be de minimis."
Analysts said Moody's was trying to send a message to Congress that investors are growing nervous and impatient with the lack of progress in negotiations to raise the nation's debt ceiling.
The U.S. stock markets took the news from Moody's, S&P and China in stride, instead focusing on an upbeat earnings report from big bank JP Morgan and news that jobless claims dropped last week.
The Treasury has maxed out its borrowing at $14.2 trillion and without congressional authority to borrow more will be unable to pay all its bills beginning Aug. 2, according to Treasury Secretary Tim Geithner.
Federal Reserve Chairman Ben Bernanke appeared before Congress and warned lawmakers not to allow a default.
"If we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world," he said.
"It's the foundation for most of our financial — for much of our financial system," he added. "And the notion that it would become suddenly unreliable and illiquid would throw shock waves through the entire global financial system."
Back before Congress on Thursday, Bernanke warned the failure to raise the debt ceiling would increase the federal deficit by driving up interest costs on the nation's debt and cutting revenues by slowing growtht. He said it would be a "self-inflicted wound."
An actual default would likely be short-lived and so probably would result in a downgrade of a single notch, from the current top Aaa rating to "somewhere in the Aa range."
Still, such a move would force many institutional investors to dump billions of dollars of holdings from funds that are required to hold only the most highly rated bonds. That, in turn, would boost market interest rates and lead to a potential cascade of market effects.
Moody's review for possible downgrade affects not only Treasury securities but also related securities issued by Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks.
Moody's and other credit agencies had warned previously that they would consider downgrading U.S. debt if the government defaults on its debt payments or even comes close to it.
"What is new, though, is their saying they'll likely assign a negative outlook even if the debt ceiling is raised but no substantial agreement toward long-term deficit reduction is achieved," said Brad Bechtel, managing director of Faros Trading in Stamford, Conn. "That's a real negative for markets."