By Peter Schroeder - 07/29/11 09:11 PM EDT
The "limited magnitude" of both debt plans put forward by congressional leaders would not put the nation's AAA credit rating back on solid footing, Moody's Investors Service announced Friday.
"Reductions of the magnitude now being proposed, if adopted, would likely lead Moody's to adopt a negative outlook on the AAA rating," the credit rating agency said in a new report. "The chances of a significant improvement in the long-term credit profile of the government coming from deficit reductions of the magnitude proposed in either plan are not high."
It added that "prolonged debt ceiling deliberations" have increased the odds of a downgrade, but that the firm is still confident policymakers will avoid a default.
"It remains our expectation that the government will continue with timely debt service," the firm said.
It also clarified that as far as it is concerned, the nation will only default if it misses an interest or principal payment on U.S. debt, not if it misses payments on other obligations like federal employee salaries or Social Security benefits.
"If the debt limit is not raised before August 2, we believe that the Treasury would give priority to debt service payments and could thus postpone a potential debt default for a number of days," it said. "Revenues would be more than adequate for some period of time to meet those payments, although other outlays would be severely reduced as a result."
Moody's previously put the nation's top credit rating on watch for a downgrade on July 13, as lawmakers continue to fight over a deal to raise the debt limit.
While Moody's is confident it will not have to downgrade the nation's rating because of a default, it maintained that long-term debt and deficit problems will continue to weigh on the AAA mark.
As Republicans and the White House fight over the length of a debt limit increase, Moody's said it would not reaffirm the nation's AAA rating unless there is at least a six-month boost to the debt limit.
However, if the nation were to default for a short period of time, Moody's said it would knock its credit rating down to AA, under the assumption that the default would be quickly rectified and investor losses would be minimized. However, in the "extremely unlikely" situation that investors do lose on Treasury investments, a lower rating could be given.
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