June 8, 2011 / 2:42 PM / 8 years ago

Fed: Default would be dangerous; Fitch may cut rating

NEW YORK (Reuters) - A default would have severe reverberations in global markets, a top Federal Reserve official said just hours after Fitch Ratings warned it could slash credit ratings if the government misses bond payments.

The Fitch Ratings building is seen in New York May 7, 2010. REUTERS/Jessica Rinaldi

St. Louis Federal Reserve Bank President James Bullard told Reuters on Wednesday “the U.S. fiscal situation, if not handled correctly, could turn into a global macro shock.

“The idea that the U.S. could threaten to default is a dangerous one,” he said in an interview.

“The reverberations in those global markets would be very severe. That’s where the real risk comes in,” Bullard warned.

Some Republican lawmakers have said a brief default, which would be inevitable in August if lawmakers fail to raise the nation’s $14.3 trillion debt ceiling, might be acceptable if it forces the White House to deal with large budget deficits.

Bullard’s warning came just after Fitch said it would slash to “junk” the ratings on all Treasury securities, seen worldwide as a risk-free investment, if the government misses debt payments by August 15.

The ratings would go back up once the government fulfills its debt obligations, but probably not to the current AAA level, Fitch said, in a stark statement about the impact of even a short-lived default on the credit-worthiness.

“The notion of flirting with a default on existing obligations flirts with irresponsibility,” Richard Bernstein, chief executive of Richard Bernstein Capital Management LLC, said at the Reuters 2011 Investment Outlook Summit in New York.

The White House said Fitch’s warning makes it clear that “there is no alternative to raising the debt ceiling.”

“This is not about additional spending, this is about honoring the obligations the United States government has made,” White House press secretary Jay Carney told a daily briefing.

Moody’s and Standard and Poor’s have issued similar warnings. But Fitch was the first among the big-three rating agencies to say Treasury securities could be downgraded, even for a short period, to a non-investment grade.

The agency said even a short-lived default, also called a technical default, “would suggest a crisis of governance from a sovereign credit and rating perspective.”

“Clearly the political signals which are coming (from Washington) are a source of concern,” David Riley, head of sovereign ratings at Fitch, told Reuters in an interview.

He added, however, that the agency still believes lawmakers will eventually reach an agreement on the debt ceiling.

“We know from previous experiences — both with the government shutdown and previous episodes with the debt ceiling — that although you get a lot of brinkmanship, ultimately it does get resolved,” Riley said.

President Barack Obama is trying to win congressional approval to raise the nation’s legal debt ceiling before an August 2 deadline.

The Treasury Department said on Wednesday the Fitch warning was “another stark reminder” of the need for Congress to act quickly.

PATH TO DEFAULT

Fitch said it would first place ratings on “watch negative” if lawmakers failed to enact an increase in the debt ceiling by August 2, when the Treasury will have run out of extraordinary measures to avoid a default.

The first test for ratings will come two days later, when $30 billion worth of Treasury bills mature. If the government fails to repay them in full, Fitch will lower the rating on those specific securities to B-plus, four notches into junk territory.

But the real deadline comes on August 15, when $27 billion in Treasury notes and $25 billion in coupon payments come due. If the government misses those, Fitch would downgrade the sovereign issuer ratings to “restricted default” and lower all Treasuries securities to B-plus.

“Though such an event (such as a short-lived Treasury bill default) may not permanently impair the capacity of the government to service its obligations, it is unlikely that its ‘AAA’ status would be retained in the short to medium term,” Fitch said.

Treasury Secretary Timothy Geithner has warned the United States could face a catastrophic default that would roil global markets if Congress does not raise the debt ceiling by then.

Moody’s warned last Thursday that it could consider cutting the United States’ top-notch credit rating if there was no progress by mid-July on a deal to reduce the deficit and raise the debt limit.

Additional reporting by Daniel Bases and Burton Frierson; Editing by Chizu Nomiyama

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