U.S. Debt Ceiling Dilemma: Moody's Says Do Away With It

Less than one week after Moody's Investors Service put the U.S. government's bond rating on watch for possible downgrade from its AAA rating, the agency suggests the U.S. should get rid of the statutory limit on government debt currently causing uncertainly for bond holders and angst among U.S. lawmakers grappling weeks on-end through bipartisan meetings over whether or not to raise the debt limit.

Political leaders have been meeting in Washington to try and agree to raise the U.S. debt ceiling by August 2, the deadline, because America it near its current $14 trillion debt ceiling limit, imposed by legislative authority.

Moody's says, however, that America's legislative debt limit has not been effective in curbing the rise of government debt over the years because when the ceiling is reached lawmakers merely have to approve a higher debt limit.

But having the debt ceiling in place causes angst among bondholders simply because when the debt limit is reached, and the deadline for raising is approached without positive action, debt holders become threatened that perhaps the U.S. won't be able to make good on its financial obligations.

We would reduce our assessment of event risk if the government changed its framework for managing government debt to lessen or eliminate that uncertainty, Moody's analyst Steven Hess wrote in a report discussing the issue.

The U.S. is but one of a few countries globally where Congress sets a ceiling on government debt, creating period uncertainty when it is approached without resolve. The lack of progress among American lawmakers approach the Aug. 2 deadline to raise the debt ceiling is the primary reason Moody's put the U.S. government's bond rating on a watch list for possible downgrade.

Elsewhere, the level of deficits is constrained by a 'fiscal rule,' which means the rise in debt is constrained though not technically limited, Moody's said.

Changing the legislative practice, by elminating the debt ceiling, would eliminate the need now and into the future for placing the U.S. on a watch list for downgrade when otherwise the nation is considered at very low risk for default.

Should legislative leaders reach compromise, raising the debt ceiling in time for America to expand beyond its current limit of $14 trillion then Moody's is expected to confirm its current AAA rating on the U.S. government's bonds.

Moody's noted that the U.S. debt ceiling has little merit since in reality lawmakers can regularly approve expenditures that go beyond federal government income, raising America's debt burden regardless. The debt ceiling is merely a formality that can become problematic if Congress debates on raising the debt ceiling as it is doing now.

Moody's currently rates the U.S. at AAA its highest rating. Moody's cited last week the rising possibility that the statutory debt limit will not be raised on a timely basis due to the lack of progress in legislative negotiations.

If the U.S. doesn't raise the debt limit in a timely basis, t would lead to a default on U.S. Treasury debt obligations.

Moody's also said last week it had placed on review for possible downgrades its ratings on financial institutions linked directly to the U.S. government, including Fannie Mae and Freddie Mac.