Moody’s Ups the Threat Level to Orange

Ratings agencies have started warning us that they’ll downgrade U.S. debt from AAA if we don’t get a debt ceiling agreement soon. But it’s never really been clear to me why anyone should care about this, since no one thinks that Moody’s or Standard & Poor’s has any special insight into the creditworthiness of the U.S. bond market. If there’s no debt ceiling deal, then Treasury rates will probably go up, but they’ll go up because investors read the newspaper and think that things are getting dicey, not because they got a press release saying that one of the ratings agencies officially put America on credit watch.

But this is different:

At least 7,000 top-rated municipal credits would have their ratings cut if the U.S. government loses its Aaa grade, Moody’s Investors Service said. An “automatic” downgrade affecting $130 billion in municipal debt directly linked to the U.S. would occur if the federal level is reduced, Moody’s said yesterday in a report. Additionally, top-rated securities with no direct links to the national government will be reviewed for similar action.

….Issuers that are partially dependent on the federal government, such as states receiving Medicaid matching funds, also will be reviewed for vulnerability. Medicaid is a health- care program for the poor that is jointly funded by the states and the U.S. Moody’s said Aaa-rated states on average rely on the federal government for a quarter of total spending.

Investors do care about the credit ratings of state and municipal governments, and if a Moody’s downgrade affects them, it will have an immediate effect on their ability to raise money. Moody’s, I’m sure, knows perfectly well that their rating of federal debt doesn’t really matter that much, so this sounds to me like a case of upping the ante. It’s a clear threat to Washington to get a deal done or face consequences from Wall Street.