Archive for July 28th, 2011
In her column in the Financial Times, Gillian Tett poses five questions for the Fed and Treasury Department. If the Republicans hadn’t linked the budget to the debt ceiling, none of these questions would have to be asked.
● What might the US government do to support the US money market funds if American debt is downgraded, or suffers a technical default? These funds currently hold a large volume of Treasuries, and if Treasury bonds tumble in value – or go into technical default – this could erode the net asset value of these funds. This, in turn, could potentially spark a run on these funds of the type that started to occur in 2008, particularly since these funds (unlike bank deposits) are not protected. But since this might have systemic implications, it is uncertain whether the government will – or will not – act.
● Will the US authorities step into the markets and act as the dealer or financier of last resort, if parts of the market freeze up? Right now, it seems unlikely that Treasury bonds would become illiquid after any downgrade; after all, this is the deepest bond market in the world. But a downgrade of US debt could, ironically, force some asset managers to sell more risky instruments (such as triple B bonds) to maintain average ratings benchmarks in their portfolios. That might create bottlenecks. There is also a risk the so-called repurchase (or repo) market might freeze. That would almost certainly prompt the government to step in (by accepting bonds as collateral and making loans); how this might work, though, is uncertain.
● What will regulators do about capital standards if some banks’ balance sheets balloon? In recent weeks, signs have already emerged of a flight of money towards supposedly “safe” banks in Europe and the US; if this accelerates, it could mess up some banks’ attempts to tidy up their balance sheets. Bankers guess that regulators will be lenient; but – again – this is unclear.
● How will regulators and risk managers respond if the “risk-free” status of US debt starts to crumble? Treasuries are currently zero risk weighted for bank capital adequacy purposes. Bank supervisors are unlikely to change this. However, some banks are reviewing collateral policies. On Thursday the Chicago Mercantile Exchange raised collateral haircuts for clearing Treasuries.
● What rules will apply for paying interest, accrued interest and principal on Treasury bonds, if a technical default occurs? On a normal day, asset managers and custodian banks make huge numbers of payments to investors, linked to the treasury market; but many institutions are uncertain what to do if a technical default occurs.
From John McCain’s speech on the floor of the Senate:
The idea seems to be if the House GOP refuses to raise the debt ceiling, a default crisis or gradual government shutdown will ensue and the public will turn en masse against Barack Obama. The Republican House that failed to raise the debt ceiling would somehow escape all the blame. Then Democrats would have no choice but to pass a balanced budget amendment and reform entitlements, and the Tea Party hobbits could return to Middle Earth having defeated Mordor. The reality is the debt limit will be raised one way or another. The only question now is how much fiscal reform and what political fallout.
From Wikipedia, for the uninformed (like me):
In J. R. R. Tolkien’s fictional universe of Middle-earth, Mordor or Morhdorh (pronounced [ˈmɔr̥dɔr̥]; from Sindarin Black Land and Quenya Land of Shadow) is the dwelling place of Sauron, in the southeast of northwestern Middle-earth to the East of Anduin, the great river. Orodruin, a volcano in Mordor, was the destination of the Fellowship of the Ring (and later Frodo Baggins and Sam Gamgee) in the quest to destroy the One Ring. Mordor was unique because of the three enormous mountain ridges surrounding it, from the North, from the West and from the South. The mountains both protected the land from an unexpected invasion by any of the people living in those directions and kept those living in Mordor from escaping. Tolkien is reported to have identified Mordor with the volcano of Stromboli off Sicily.
This is the old John McCain speaking — the one I long-respected, whose primary campaign I contributed to, and who I planned to vote for in 2008. Then he picked Sarah Palin as his running mate . . .
On occasion, the WSJ doesn’t enforce its subscription barrier. I sent the following link to my wife, who was able to access the article on her computer.
http://professional.wsj.com/article/SB10001424053111903999904576470551476951590.html?mod=WSJ_Opinion_LEADTop&mg=reno-wsj
Give it a try if you’re not a subscriber.
The Financial Services Forum (FSF) is “a non-partisan financial and economic policy organization comprising the CEOs of 20 of the largest and most diversified financial services institutions doing business in the United States.” Today, the FSF sent a letter to President Obama and Congress on the nation’s debt. Here it is, in full:
Dear Mr. President and Members of Congress,
We write to you today to urge you to act this week to reach an agreement that will ensure that our Nation continues to meet all of its financial obligations, and that will entail meaningful and concrete steps to put our Nation on a sound fiscal footing. The consequences of inaction – for our economy, the already struggling job market, the financial circumstances of American businesses and families, and for America’s global economic leadership – would be very grave.
Our economic recovery remains very fragile. A default on our Nation’s obligations, or a downgrade of America’s credit rating, would be a tremendous blow to business and investor confidence – raising interest rates for everyone who borrows, undermining the value of the Dollar, and roiling stock and bond markets – and, therefore, dramatically worsening our Nation’s already difficult economic circumstances. Given this very real risk, policymakers must correct our fiscal course now, inspire market confidence by paying all of our bills on time, and demonstrate that America is a democracy capable of putting differences aside to solve our most challenging problems.
A credible and predictable path forward, entailing tough decisions on the budget, will create the needed environment for businesses and entrepreneurs to start, grow, innovate, and create high quality jobs for Americans, now and in generations to come.
We strongly urge you to reach an agreement this week.
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I rarely find myself in agreement with CNBC’s Larry Kudlow. But, in this instance, I am. Kudlow is now sufficiently worried about a downgrading of the U.S. credit rating to have set ideology aside. His interview with Standard & Poor’s David Beers is revealing.
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BusinessWeek’s Peter Coy is gloomy:
For all our obsessing about it, the national debt is a singularly bad way of measuring the nation’s financial condition. It includes only a small portion of the nation’s total liabilities. And it’s focused on the past. An honest assessment of the country’s projected revenue and expenses over the next generation would show a reality different from the apocalyptic visions conjured by both Democrats and Republicans during the debt-ceiling debate. It would be much worse.
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The New York Times says that “America’s Credibility Is at Risk”:
. . . a [credit rating] downgrade would be a blow to American credibility and prestige, made all the worse for coming so shortly after the made-in-America global financial crisis. As a correspondent for the German newspaper Die Welt wrote a few days ago, “Out of the American 21st-century crisis could come the downfall of the dominant power of the 20th century.” That may be overheated. But no one can shrug it off. The markets and the rest of the world are worried, and they should be. We all should be.
Ronald Reagan is a hero of the Tea Party. Perhaps these obstructionist members of Congress should do a little research. If they did, they’d find that in a radio address on September 26, 1987, the Gipper said this:
“Congress consistently brings the Government to the edge of default before facing its responsibility. This brinkmanship threatens the holders of Government bonds and those who rely on Social Security and veteran benefits. Interest rates would skyrocket. Instability would occur in financial markets and the Federal deficit would soar. The United States has a special responsibility to itself and the world to meet its obligations. It means we have a well-earned reputation for reliability and credibility, two things that set us apart from much of the world.”
By the way, I voted for Reagan.