By Peter Schroeder - 05/09/13 02:11 PM EDT
The nation's credit rating agencies are wary of a House Republican plan to prioritize payments to U.S. bondholders and Social Security recipients if the debt ceiling is reached.
GOP leaders have cast their Full Faith and Credit Act, which is set for a House vote on Thursday, as a way to avoid the most damaging aspects of hitting the debt limit.
Nikola Swann, the primary analyst for the U.S. rating for Standard & Poor's, pointed out that if a prioritization plan were in place, reaching the $16.4 trillion borrowing limit would still carry potentially huge economic and financial consequences.
The government would cut bond payments and Social Security checks, but a whole range of other government payments would be cast into doubt. The impact would be "perhaps even a little bigger" than the "fiscal cliff" that threatened the nation's economy at the end of 2012, he said.
The U.S. might be able to avoid a literal default on its debt obligations, but the resulting turmoil could still chip away at the nation's credit rating.
“It’s not guaranteed that fiscal shock would cause a downgrade by itself, but it’s certainly within the realm of possibilities depending on the other circumstances," he said. "You may well avoid D [the default rating] … but you could still be going lower than AA-plus."
S&P downgraded the nation following the last major debt limit fight during the summer of 2011. A key criterion in its rationale to drop the U.S. to AA-plus for the first time ever was the political standoff over raising the limit.
The new House bill is highly unlikely to become law given the White House's veto threat, but even if it did, credit raters said it would not ensure avoidance of another downgrade.
Swann said adopting a prioritization plan would do nothing to assuage the concerns that led to the S&P downgrade.
"I don’t think there’s anything about that opinion that would be improved by the passage of such legislation, because the whole point of such legislation is to say, ‘If we can’t agree on anything, and we get ourselves into a self-made crisis, this gives us a little more breathing room," he said.
It’s unclear if Treasury can prioritize its payments as outlined by the House GOP bill.
The bill would allow Treasury to continue to issue debt above the borrowing limit to cover payments on interest and Social Security. But that department has maintained in past debt limit standoffs that it simply cannot prioritize payments in that fashion, as hundreds and even thousands of payments are processed by the Treasury each day, making it nearly impossible to prioritize some payments.
Fitch Ratings, one of two raters that still keep the U.S. at its top-shelf AAA rating, warned in a February report that anything short of raising the debt limit in a "timely fashion" would prompt a review and likely downgrade of the nation's credit rating.
When asked if a prioritization plan could avoid such a review, a spokesman for the agency reiterated that the only way to ensure the U.S. can avoid a downgrade is with a "timely increase combined [with a] more credible and sustainable debt reduction plan."
Moody's Investors Service is more sanguine.
In February, it said that the debt limit is not a "fundamental factor" in its assessment of the nation's triple-A rating.
Regardless of the GOP legislation, Moody’s said Treasury would ultimately ensure interest payments on the debt would be made if the limit is not raised by Congress.
They pointed out those interest payments account for roughly six percent of government expenditures, meaning there is "ample room" for the government to line up cash to pay those obligations.
"Moody's is unlikely to institute a formal review of the government's rating because of the debt limit alone," it said.
Moody's has said it will reassess the nation's top rating throughout the course of the year, and considers a downgrade more likely than not unless Washington finds a way to strike a deal to reverse its growing debt trajectory.
Both Fitch and Moody's have placed the U.S. rating on a negative outlook, effectively warning that a downgrade will be on the way if the nation fails to address its long-term debt issues in 2013.
The debt limit is currently suspended due to a prior agreement struck earlier this year, but will be reinstated May 19. The limit will automatically be hiked to cover borrowing over the three months it was suspended, and assuming no new deal has been struck on raising the limit by then, the Treasury would begin employing "extraordinary measures" to work around the limit and avoid a default.
Outside analysis estimates that such measures would prevent the ceiling from being breached until fall.