Moody's warned that a backup plan floated by Sens. Reid and McConnell should include spending cuts.
NEW YORK (CNNMoney) -- Credit rating agency Moody's dinged a key backup plan to raise the debt ceiling Monday, and said the United States would be better off if the ceiling was eliminated entirely.
On Monday, Moody's threw some cold water on a backup plan that is gaining momentum among lawmakers as the chances of a compromise deal fade.
The plan, crafted by Sens. Mitch McConnell and Harry Reid, would allow the debt ceiling to be increased, while shifting the political blame for that action from Congress to the White House.
The measure would allow for three short-term increases of the debt ceiling while at the same time letting lawmakers register their disapproval. The first increase would boost the debt limit by $700 billion and the next two by $900 billion each.
Moody's said that part of the plan would reduce pressure.
"Any proposal that reduced the risk of payment disruptions would be a positive step in the short term," the report said.
But Moody's warned the measure should include substantial spending cuts as well.
"Without more substantial deficit reductions being included in such a plan, it would be negative for the long-term outlook," the report said.
The details of the plan have yet to be ironed out, and it's possible that the final bill will include spending cuts. McConnell and Reid are reportedly considering adding a basket of spending cuts to the package, but nothing has been finalized.
In addition, Moody's suggested the U.S. would be better off if the debt ceiling were eliminated entirely.
The limit has not effectively restrained spending, Moody's notes, and the legislative process "creates periodic uncertainty over the government's ability to meet its obligations."
"We would reduce our assessment of event risk if the government changed its framework for managing government debt to lessen or eliminate this uncertainty," the report said.
Moody's said that because lawmakers have consistently acted to raise the debt ceiling, it had not considered the event high risk in the past. But the situation is different now.
"The currently wide division between the House of Representatives and the Obama administration over the debt limit creates a higher level of uncertainty and causes us to raise our assessment of event risk," the report said.
Moody's said last week it would likely change its outlook on the AAA rating to "negative" from "stable" unless "substantial and credible agreement is achieved on a budget that includes long-term deficit reduction."
Moody's didn't define specifically what it meant by a "substantial and credible" agreement for debt reduction, but presumably having absolutely no agreement would not qualify.
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