Still, no Armageddon, unless . . .
I think we're looking at a gradual worsening of the U.S. global financial posture. But that doesn't count as Armageddon, because that's pretty much what investors have been looking at for years. Do you know anyone who is surprised at this trend?
My big worry is that the current slow erosion of faith in U.S. Treasurys will turn into a cascade of unanticipated consequences if the debt ceiling isn't raised. Treasurys play a unique role in the global financial markets. They aren't important only because they're jammed into so many global portfolios, including the portfolios of so many of the world's countries. They're also important because they serve as collateral on a huge percentage of the complex deals that use derivatives to shift risk around the globe.
It's that role that makes me think Armageddon is a possibility. It's a remote possibility, I think. But given the very limited information about these markets and the balance sheets of the players, I can't say with any degree of certainty how small the possibility might be.
A look at repo market
For example, Treasurys are used as collateral for cash loans in the repo (repurchase) market. In a repo agreement, the seller of a security agrees to buy it back from a buyer at a higher price on a specified date in the future. Repos are, in effect, short-term loans; they are used to raise short-term cash by banks and corporations. Central banks, such as the Federal Reserve, also use them to manage the money supply. To expand the money supply, the Fed decreases the repo rate at which it buys back government debt instruments from commercial banks. To shrink the money supply, the Fed increases the repo rate.
It's a huge market. Bank of America Merrill Lynch estimates that 74% of primary dealer repo financing -- or about $2.1 trillion -- involves Treasurys as collateral. And you don't have to be JPMorgan Chase (JPM, news) or the European Central Bank to have exposure to this market. Money market funds have big chunks of their cash in the repo market. (Anyone who remembers the problems that the Lehman crisis created for money market funds should regard any advice on using money market funds as a safe haven in the event of a U.S. default with extreme skepticism.)
And this is just one of the markets that uses Treasurys as collateral. According to estimates by JPMorgan Chase, about $4 trillion in U.S. Treasury debt is used to back deals.
The truth, though, is that no one knows exactly what would trigger problems in one or more of these markets. We do know, though, that Wall Street is worried. The Financial Times has reported that Matthew Zames, an executive at JPMorgan Chase and chairman of the Treasury Borrowing Advisory Committee, wrote in April to Treasury Secretary Timothy Geithner that "a default could trigger a wave of margin calls and a widening of haircuts on collateral, which in turn could lead to deleveraging and a sharp drop in lending." On July 15, the Securities Industry and Financial Markets Association held a meeting with staff from the big banks to discuss the effects of a U.S. default on those markets.
Watch the ripples
The ripples from any default or downgrade of the U.S. credit rating would spread out like this: Investors who lent cash against Treasurys as collateral would require more bonds to back their loans. That would force borrowers to find cash, sell other assets or close their repos and other positions. And that would set off a wave of deleveraging very similar to the one that swept the financial markets in the wake of the Lehman bankruptcy in September 2008. We could get a replay of the credit crunch that almost brought down global financial markets and the global economy in 2008. (And this time the Federal Reserve would be unable to ride to the rescue.)
As I say, I think this is a remote scenario. But what troubles me is that almost three years after the Lehman bankruptcy, the global financial system remains pretty much the opaque network of undisclosed and unregulated leverage it was then. Very little has changed that would prevent a replay of that crisis.
To me, such a rerun would qualify as Armageddon -- and that makes me wonder why nobody who is trying to get this debt ceiling deal done is explaining to voters this aspect of the danger we all face. Maybe it is too complicated -- not for voters but for the politicians who sit in Washington. Certainly we've seen a very convincing demonstration over the last few weeks of Washington's abysmal level of understanding of finance and economics.
Why didn't they fix this?
But I can't help thinking that there's something else at work. Neither party really wants to draw attention to the fact that it did so little to fix the system that produced the last crisis. The Republicans have concentrated on gutting a system of reforms, even before the regulations for them have been written, but nobody thinks the reforms being so tepidly defended by the Democrats in Congress and in the White House really get at the problems that contributed to the last crisis.
Above all, I suspect, nobody wants to admit that the pain a failure to raise the debt ceiling and a downgrade of the U.S. credit rating following a default would inflict on the average voter isn't enough reason to reach a deal. But that worries from Wall Street might well be.
When the country remains as angry as it has every right to be about Wall Street's ability to escape the consequences of the last crisis, I doubt that anyone in Washington wants to remind voters that the folks in D.C. listen to Wall Street and ignore Main Street.
At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column in his personal portfolio. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. Find a full list of the stocks in the fund as of the end of March here.
Jim Jubak's column has run on MSN Money since 1997. He is the author of the book "The Jubak Picks," based on his market-beating Jubak's Picks portfolio; the writer of the Jubak's Picks blog; and the senior markets editor at MoneyShow.com. Get a free 60-day trial subscription to JAM, his premium investment letter, by using this code: MSN60 when you register at the Jubak Asset Management website.
Click here to find Jubak's most recent articles, blog posts and stock picks.
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FIRST..in this case there should not be democrats or republicans or liberals etc..they all are, and should think like AMERICANS!
SECOND..pull our troops out of afghanistan, iraq, syria, lybia et al. save countless lives of our troops AND save billions of $$$ which could/should be used to address problems here at home.
THIRD..the politicans(republicans) are holding fast on no tax increases..they are not increases but a return to the correct tax rate that was in place BEFORE the bush cuts.
FOURTH...keep your damn hands off my social security benefits. this is NOT an entitlement or a handout. i (read all working americans) paid into this our entire working life so it is a return of investment NOT a handout of any kind.
FIFTH..let the senate and congress pay, as we do, for their medical insurances, have them pay into social security and impose term limits of two terms. no need for career politicians that get complacent and have too many entities they become beholden to over the long term.
SIXTH..put in place a FLAT tax rate for ALL individuals and companies. NO deductions, NO exemptions, NO exceptions, pretty much do away with the irs as we now have it, reduce the size of the tax laws to one sentence, and last but not least it would be FAIR to all.
I know these are all pipe dreams but......this country was basically founded on dreams.
I THINK WE NEED A TOTAL RECALL OF OUR GOVERNMENT FROM THE TOP DOWN. THINK ABOUT THIS ON THE NEXT ELECTION. THE PEOPLE NEED TO STEP UP AND TAKE OUR GOVERNMENT BACK . THE WHOLE GOVERNMENT NEEDS A WAKEUP CALL.
A few billion here and a few billion there, it all adds up. 40 billion for foreign aid to countries that want to wipe America off the face of the earth. Seems like a good place to start making cuts.
Its time that this country stand up to each and everyone of these people and tell them they work for us not the other way around and get this country back on top. I'm tired of he said she said BS who cares what your party is, its AMERICA people. Get rid of the ones in this country that are not suppose to be here, stop handing money to the crack heads for free without a piss test, stop jacking with social security for the people who worked their back sides off to earn that money. I dont care what color the man that is suppose to be in charge but damn you over paid politicians get your crap together and get this country back on track.
I hear about all of these cuts, SSI, SSID, military, other so called etitlements, but I haven't heard whether Congress and the President would get paid or not. And that is exactly what should happen. If we all have to suffer cuts or not receive pay, Congress and the President shouldn't get paid. After all, they are the root cause of all of this!!
Let's call a spade a spade. There is no agreement on the debt ceiling because both parties think they can make political gain in 2012 by sticking to their guns.
The Republican have a new dogma about no tax increase and are willing to bet the house on it, the Democrats are hell bent on keeping the big programs (so called entitlements) as they are.
In the meantime, the country is stuck in the middle and to the rest of the world we look at a banana republic, nice image for the most powerful country on earth...
In this game of chicken nobody wins.
One of the first order of business, if we do not vote to increase the debt ceiling, would be to symbolically not pay our elected representatives, both in the Congress and Senate, it will not save or help much, but it will prove a point and since neither chamber has shown that they are an essential service (if they were they would have made a deal), then they should be the first one to suffer for their stupidity.
Regardless of the partisan debate, the debt ceiling must be raised in order for the country to continue functioning normally. In the meantime, our elected representatives must start to look at the level of spending and start making some painful cuts as well as raising taxes and reforming the tax code, then we can look at having a balanced budget on an annual basis.
But that takes a serious dose of political courage and will not happen before 2012. So we are stuck in neutral for another 15 months, with the american public and the world shaking their heads.
I think we shouldn't pay our elected officials (Democrats and Republicans) because they are fighting
back and forth not wanting to find a solution. This whole thing is about Politics and not what's best for the
First off we don't need 100 Senatores. 50 is enough, 1 from each state. the second one does nothing anyway.
Slash the house by a third, that is plenty of representatives.
End their pension plans and let them join Social Security, like the rest of us.
For those over 65 put them in medicare, just like us or buy your own. No Gov't handouts. ( The tea party congressmen should like that)
No more pork, give the president a line item veto.
Term limits. President 1 term 6 years
Senators 1 term 6 years
house members 1 yerm 3 years.
Now we wont have to worry about them spending time electioneering.
WOW we are saving millions already, and that is just the begining.
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Top-weighted sectors (sans financials) remain in the red, and the discretionary space has widened its loss to 0.5%. Homebuilders took a hit this morning in reaction to a disappointing New Home Sales report and the iShares Dow Jones US Home Construction ETF (ITB 23.28, ... More
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