Wednesday, July 27, 2011

Fed and the Debt Limit

Very interesting piece in the FT:
Wall Street bankers, from senior executives to traders, are complaining that the Federal Reserve is refusing to engage in scenario planning for a US downgrade or default.

With days until the Treasury’s August 2 deadline to raise the debt ceiling, bankers say they are not getting a response to efforts to discuss the market impact of a failure to reach a deal in Washington or if credit ratings agencies cut the US triple A rating.

Banks are concerned about a wide range of operational issues as well as the broader question of how the Fed would support the financial system if there were disruption caused by a failure to raise the debt ceiling.

For example, they would like to know whether the Fed would be willing to lend against Treasuries with a defaulted interest payment, which would support the repo market. At a broader level, they would like to know whether the Fed will support the refinancing of Treasury securities by stepping in and buying any unsold stock at auctions.

In terms of the overall financial system, banks want to know what support the Fed would offer if there were a run on money market funds – knowing the Fed will provide them liquidity would reduce the chance of such a run.

They also want to know how the Fed would handle their capital and liquidity regulation if, for example, Treasuries fell in value or they experienced large inflows or outflows of deposits and how principal and interest payments would be made.


Anonymous said...

This is an almost entirely manufactured "crisis", if you can even use that word.

There is NO chance (zero, zip, nada) that the US is going to default in the true sense of the word, that is, fail to make payments on its debt. Not going to happen. Being zero risk of real default, there is close to zero reason to downgrade the debt (which is why you aren't hearing anything about downgrades even in the event that a deal is reached from anybody other than S&P).

What might happen is essentially a partial government shutdown (or "brownout") as the Treasury decides what non-debt payments it will make. If the ceiling is not lifted, some people are not going to get paid, but it will NOT be the bondholders or holders of any other form of US government debt. If this kind of thing went on long enough, you might eventually put real default on the table. However, long before that point irate voters would be hammering their reps because all kinds of services to which they have become accustomed would not be available. That kind of pressure results in something getting done.

A downgrade by S&P, if it happens at all (which appears to me to be no more than a 50/50 deal based on commentary), would have little effect on anything. Most US debt is held by institutional investors (funds, governments, etc.). These people do not rely on S&P ratings to decide their investments. They do their own research. They know that the US, owner of the world's reserve currency, is not going to default on debt payments. Since they know this, there is no reason to panic, no power selling, no significant upward pressure on rates. Some pressure? Probably? A lot. I doubt it.

Could the stock market flip out? Sure, there are lots of interests that like the volatility and could push that in order to cream more money off the sheep in the market.

Does any of this warrant Fed intervention? No. Is there anything they could do that would actually be helpful to Americans? No. They could, of course, dump more money into the hands of the financial sector, continuing a pattern that has gone on for 4 years now (at least). If they do anything, that is probably what will happen.

All in all, an embarrassing state of affairs for a country that calls itself the "world's leading democracy."

chris said...

Maybe that's the Fed's way of telling the banksters to bring their Republican dogs to heel.
"You break it you own it."