Connelly on Commerce

Terry Connelly is dean emeritus of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Most people in the US according to the latest polling do not support raising the ‘debt ceiling” and accordingly are willing to live with a US default on its “full faith and credit” obligations, which of course includes not just our interest payments to foreign and deomestic bondholders but also Social Security checks,  Veterans benefits, tax refunds and other obligations of the US Treasury — over 80 million separate checks per month.

But wait a minute, you say — I didn’t mean the Government should stop paying what it owes ME! And I hold Treasury bonds in my IRA, my folks get Social security, my cousin is a disabled Vet, and my wife has a tax refund due.

But it gets worse: far worse, and only the new class of political demagogues and their co-dependents in cable media, coupled with the failure of mainstream media to really investigate and spell out what easily predictable consequences of default would be,  stand between you and a cold shower of reality of what a failure to reach a deal on raising the debt ceiling will mean. Let’s take that showe, step by step:

1) Senior Congressional leadership and the President either fail to reach a deal by July 22, or discussions break down: then all three bond rating agencies will put the US on credit watch with a warning of imminent downgrade to ‘default” status.

2) The bond markets will finally react very adversely to the prospect of default and interest rates on all manner and maturity of debt instruments will spkie sharply, and the stock market will fall 500 pints or ore in one day.

3) The negotiators re-convene and try to push a shorter-term deal through the Congress before August 2but fail in the House of Representatives (as they did initially with TARP — again because the public didn’t understand what it meant to them): the bond and stock markets only get worse, as the rating agencies give some form of final warning.

4) August 2 comes and goes with no deal; the Treasury triages its outflows, continuing to pay interest on outstanding bonds and notes and bills, but cannot undertake new borrowings  to roll over principle due, and necessarily defaults on Social Security or other  payments due to US citizens; despite the continued debt service payments, the rating agencies, noting the intransigence of Congress and cancellation of refundings,  quickly downgrade the ratings on all US Treasury obligations as low as  ”D” — lower than junk.

5) Overnight, the banking system around the world freezes up even worse than in the Lehman debacle, because all overnight lending between them (the so-called “repo” market), which is the grease for the global wheel of routine banking transactions, grinds to a halt with universal uncertainty about the balance sheets of every holder of Treasuries.

6) Commerce as we know it ceases because all payments are frozen. Money market fund values will fall precipitously; the Treasury  security holding of most US banks, insurance companies  and pension funds will become practically worthless, because they will no longer be authorized to carry them in their “AAA” basket, and yet they will be unable to dispose of them even in a “fire sale” because the logical buyers will be in the same situation(not to mention the US Federal Reserve, the usual buyer of last resort). Congress would neeed to act immediately to authorize the Fed to hold the “D” rated securities if only to save ALL financial institutions, and the world’s other Central Banks would have to obtain similar authority.

7) You won’t be able to withdraw your funds from the bank because they will all close, and the FDIC will be in no position to make good on its guarnatees to the extent that it too, holds US Treasuries.

8) Global stock and bond markets will crash by thousands of points — and the bond markets will go through an equivalent collapse.

9) The price of all commodities except gold will collapse: gold will double each day (Moore’s Law 2.0), as trading gold will be the “only game in town” as Goldman Sachs partners again revert to bartering their personal gold bar caches literally on Wall street sidewalks.

10) The President will be forced to declare a national emergency and the Congress will vote again to finally approve a debt ceiling increase now that the recalcitrant  ”Tea Party” Republicans can justify their vote in favor by claiming that “the markets made us do it” — but it will be too late to avert a global Depression.

How’s that for starters? Will somebody please show where I am wrong?

Recalling, roughly,  the immortal words of Butch Cassidy and the Sundance Kid when they faced a “dive of the cliff together” moment  with the law on their tails: BUTCH: “We’ve go to jump”. SUNDANCE: “But I can’t swim”. BUTCH: “Don’t worry, the fall will probably kill ya.” In our case, it’s not just the default, it’s the downgrade that will kill us.”

 

 

 

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Bring on the downgrade! That’s what some in Washington seem to be cheering for these days — maybe enough of them to stop a vote in the House of representatives to raise the debt ceiling before the roof falls in on August 2. It’s time to get serious about this.

The credit rating agencies have made it abundantly clear that, without progress on the debt ceiling budget talks by the middle of this month, they will put the US on credit watch for a likely downgrade of the Americans Triple A credit rating. In the case of Standard & Poors, for example, that will be all the way down to “D” — for “default” — lower than junk. Now the markets may or may not react in mid-July to the rating agencies “final warning’  – Wall Street professionals cannot believe that the politicians in Washington will actually let the US go in to default onits obligations. They rightly view as sheer nonsense the idea of some that we can simply pay the interest on our credit card and let things like military pay or Social security checks fall by the wayside for a while — those latter events would be events of default, too, in the eyes of the rating agencies. They know on Wall Street all too well what the actual consequences of a “D’ rating would be. But Wall Street has lost credibility with the American voter, and too many of them have been led to believe by somem politicians and cable commentators  that a credit dwongrade or even “temporary’ default can be managed to a good outcome

Some want this downgrade to happen because they think this would seal  Obama’s doom in 2012 as the only President ever to ‘lose’ the Triple A rating or to bring on a shutdown of the government to the point where we stopped paying our Social security checks. But that’s not the half of what would happen. With a “D” rating, virtually the preponderance of the balance sheets of banks, insurance companies, pension funds and even the Us Federal reserve would become worthless overnight; the “freeze-up” of transactions among financial institutions and in commerce generally would make the Lehman event seem like a spring thaw — no bank could trust any other overnight because they would all be capital-impaired, with no market to which to sell their worthless US Treasury securities, because no other financial institution would be able to classify them as capital. There would meanwhile be a run on every bank by depositors, bankrupting the FDIC in short order, as ordinary individuals scrambled for any ounce of cash.

These are not “scare tactics”; we’ve seen the trailer to this movie before in the days after Lehman’s bankruptcy filing — but this time, it won’t just be AIG that goes under — who would rescue the Fed?  Every balance sheet stuffed with ‘safe’ US securities would be technically worthless — not because American can’t afford to pay its obligations — we are, for the moment, still a multi-trillion dollar economy — but because one particularly willful but  stupid clique of politicians believe that they need the downgrade and  default event, and the expectable stock and bond market crashes, as their excuse to vote eventually for the debt ceiling increasde AFTER the damage is done to Obama and because, as they will ex[lain to their Tea Party  "base',  "the market [which they worship] made them do it”.

It is high time for the media generally to do its homework and alert the public to what happens if this scenario comes to pass and  expose those who are shamelessly exploiting public ignorance for short-term political advantage. Although as usual it is the Tea Party denizens and Fox News that are peddling the idiocy of default as a good idea, some on both the Right and the Left are guilty as charges on this count as well, as they argue that their leaders should draw ‘lines in the sand” in the debt ceiling debate to [prevent any compromise or short-term agreement that would violate their budget principles. Lines in the sand, however,  only work in the kids’ sandbox — on a real beach, they tend to get wipes out by powerful tides.

 

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