U.S. sovereign debt downgrade : "While we see limited risk of a U.S. sovereign debt downgrade in the next 2-3 years, beyond that we cannot be so certain," wrote Societe Generale's economics team in a recent report.

U.S. Debt Shock May Hit In 2018, Maybe As Soon As 2013: Moody's


By JED GRAHAM, INVESTOR'S BUSINESS DAILY

Posted 05/05/2010 07:56 PM ET

http://www.investors.com/NewsAndAnalysis/Article.aspx?id=532490

Spiraling debt is Uncle Sam's shock collar, and its jolt may await like an invisible pet fence.


"Nobody knows when you bump up against the limit, but you know when it happens it will really hurt," said fiscal watchdog Maya MacGuineas of the Committee for a Responsible Federal Budget.

The great uncertainty about how much debt is too much has tended to make fiscal discipline seem less urgent, rather than more. There is no obvious threshold beyond which investors will demand higher real yields for holding U.S. debt. Vague warnings from ratings agencies about the loss of America's 'AAA' status haven't added much clarity — until recently.

In the wake of the financial crisis and recession, Moody's Investors Service has brought new transparency to its sovereign ratings analysis — so much so that 2018 lights up as the year the U.S. could be in line for a downgrade if Congressional Budget Office projections hold.

The key data point in Moody's view is the size of federal interest payments on the public debt as a percentage of tax revenue. For the U.S., debt service of 18%-20% of federal revenue is the outer limit of AAA-territory, Moody's managing director Pierre Cailleteau confirmed in an e-mail.

Under the Obama budget, interest would top 18% of revenue in 2018 and 20% in 2020, CBO projects.

But under more adverse scenarios than the CBO considered, including higher interest rates, Moody's projects that debt service could hit 22.4% of revenue by 2013.

"While we see limited risk of a U.S. sovereign debt downgrade in the next 2-3 years, beyond that we cannot be so certain," wrote Societe Generale's economics team in a recent report.

The Moody's ratings framework is one that could have a significant influence on policy — particularly in a crisis.

Because debt levels and interest rates can't be lowered overnight, the obvious way of staying within the AAA limits set by Moody's would be to raise revenue.

"It would bias the remedy in favor of tax increases for countries that want to improve their bond rating," said Brian Riedl, budget analyst at the conservative Heritage Foundation.

Because economic growth is a key to fiscal health, Riedl argues that a ratings agency concerned about whether bondholders are repaid should bias spending cuts over tax increases.

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