A key credit agency issued an unprecedented warning to the United States government Monday, urging the nation to get a grip on its finances or risk losing the country's sterling credit rating.
For the first time, Standard & Poor's lowered its long-term outlook for the federal government's fiscal health from "stable" to "negative," and warned of serious consequences if lawmakers fail to reach a deal to control the massive deficit.
An impasse could prompt the agency to strip the government of its top investment rating in the next two years, S&P said. A loss of the triple-A rating would ripple through the American economy, making loans more expensive and credit more difficult to obtain.
The downgrade was interpreted as a rebuke to President Obama and congressional Republicans, admonishing them to put politics aside and come up with a long-term financial plan as soon as possible.
"This is a warning: Don't mess around," said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that is pushing for deficit reduction.
Analysts at S&P have never before used the outlook to cast doubt on the nation's credit worthiness.
In response, stocks suffered their worst slide in a month. The Dow Jones industrial average plunged 245 points before recovering to close down 140 points for the day.
"The credit quality of U.S. debt is sacrosanct, and legislators will do everything within their power to avoid a downgrade," said Jack Ablin, chief investment officer at Harris Private Bank.
The government is on pace to run a record $1.5 trillion deficit this year, the third consecutive deficit exceeding $1 trillion.
But so far, S&P sees little chance that the White House and Congress will agree on a deficit-reduction plan before the November 2012 elections.
Obama and congressional Republicans are sparring over how to reduce the nation's red ink. If Congress refuses to raise the nation's debt limit this spring, and the U.S. Treasury lost authority to borrow additional money, the government would not be able to pay its bills and would default on its debt.
Although it's a worst-case scenario that's highly unlikely, default by the government means anyone owning federal debt of any kind -- bills, notes, bonds -- could go unpaid.
Both sides have proposed cutting $4 trillion from future deficits over the next 10 to 12 years.
The White House wants to reduce the deficit through spending cuts and by ending the Bush-era tax cuts for the wealthy. Republicans reject that, calling it a tax increase. They seek instead to narrow the deficit by overhauling Medicare and cutting spending elsewhere.
The credit report called the two proposals a "starting point" of the process, but warned that the gap remained wide.
A lower credit rating would drive up the government's borrowing costs. It could lead to higher interest rates on everything from mortgages to car loans and threaten to slow U.S. economic growth.
Ablin said the credit worthiness of the country is the underpinning on which all other asset classes are valued.
For now, S&P continues to give the U.S. government its top investment ranking. That means S&P believes that the U.S. government can and will repay its debts and that Treasury investments are virtually risk-free. But the agency says the United States faces a one in three chance of a downgrade in the next two years. That would likely happen if the White House and Congress could not come up with a credible plan for reducing debt.