Even if Republicans were to suddenly cave and vote Monday morning to hike the debt limit without any conditions, it would not spare the United States from the risk of a credit downgrade. In the past several days, rating agencies Moody's and Standard and Poor's have both issued warnings that they could downgrade the U.S. credit rating if the debt limit is not raised. However, they also said that the ratings could be downgraded even if a deal is reached to raise the debt limit, but there isn't a credible agreement to tackle our debt burden.
Here was Moody's:
If the debt limit is raised again and a default avoided, the Aaa rating would likely be confirmed. However, the outlook assigned at that time to the government bond rating would very likely be changed to negative at the conclusion of the review unless substantial and credible agreement is achieved on a budget that includes long-term deficit reduction. To retain a stable outlook, such an agreement should include a deficit trajectory that leads to stabilization and then decline in the ratios of federal government debt to GDP and debt to revenue beginning within the next few years.
And here's a S&P:
We may lower the long-term rating on the U.S. by one or more notches into the 'AA' category in the next three months, if we conclude that Congress and the Administration have not achieved a credible solution to the rising U.S. government debt burden and are not likely to achieve one in the foreseeable future.
S&P added that a credible plan would be somewhere in the neighborhood of $4 trillion.
So while the focus right now has been on what type of agreement would be needed to raise the debt ceiling, Congress and President Obama may have no choice but to broker a big deal in the coming months. On the one hand, this dynamic plays into the arguments we conservatives have been making about the unsustainable level of federal debt. But on the other hand, it could make it harder for Republicans to hold out for a deal that doesn't include tax increases. If the rating agencies want to be reassured soon, a "big deal" may not be able to wait for after the next election when Republicans hope to be in a better political position.
For a $4 trillion deal to even have a shot of getting in through in the current political makeup, it would clearly have to include tax hikes and steep cuts to entitlements. John Chambers, the chairman of S&P's soverign rating committee, explains in an accompanying video that the agency wants to see a deal that both Republicans and Democrats sign on to, because that will make its analysts more confident that whatever is agreed to will actually get implemented. While it's tempting to dismiss this as the opinion of yet another talking head, the reality is that a ratings downgrade would significantly boost government spending because it would make it harder for the U.S. to sell its bonds, thus increasing our interest payments substantially. So the rating agencies could force a "big deal" sooner than currently seems possible.