The Impact of Default


Greece’s sovereign debt was downgraded to CCC by Standard & Poor’s on Monday, making it the worst credit rating in Europe and the worst in the developed world. Yet, when it comes to credit downgrades and talks of default, the country the entire world is watching is right here, in the AAA rated never-missed-an-interest-payment US of A.

What impact would a US default have?

Some experts have predicted a major panic. Standard & Poor’s has made it clear that it would cut the US rating from AAA (the top) to D (the bottom). That would mean banks would technically be barred from using US debt as collateral with central banks (although these rules could be changed). As Gary Jenkins of Evolution Securities put it: “They wouldn’t dare, would they?” Even Bernanke has conceded that failure to lift the US debt ceiling would throw the financial system into tremendous disarray.

If Congress fails to balance the debt, the government would have to stop, limit, or delay payments on a broad range of legal obligations, including Social Security and Medicare benefits, military salaries, and interest on the national debt, which is paid to big, market maker banks like J.P. Morgan Chase, Citibank, and others, not to mention the government of China, which is the largest holder of US government bonds overseas. Defaulting on those obligations, including coupon payments to bond holders, would cause severe hardship for the US economy. It would erode the historic legacy of the US as the safe harbor within the global financial system.

How has America been keeping afloat since May, when the debt ceiling was reached?

By stopping payments to certain federal pension schemes, and by liquidating some of the scheme’s assets. Treasury secretary Tim Geithner has pledged that the shortfall will be repaid once the ceiling is raised.

How urgent is the situation?

The US treasury estimates that funds will dry up on 2 August. However, the deadline is actually 22 July– to give time for legislation to be written and approved.

As a Mortgage Banker, I am counting on the next couple of weeks  to be very volatile with re pricing multiple times per day.  Now is an excellent time to get your applications in so your Mortgage Specialist can lock your loan at the perfect time.



What is the Fed Thinking? When will rates rise?

The recent decline in rates is built on the view that the softer economic outlook will keep the Fed from increasing interest rates until at least the 1st Q of 2012. The Fed is unlikely to increase rates with little inflationary fears now, but does that in itself justify present low interest rates? The recent decline is mostly a safety move; with equity markets not advancing, commodity price increases are over for the moment, and borrowing demand very weak. Every technical indicator we use in our near term forecasting is bullish, from a trading perspective we are bullish, from a fundamental longer outlook we are not so optimistic. We expect the end is closing in on these low levels, that said we are not expecting a rapid increase in rates—-a slow grind higher. For now take advantage of the gifts mortgage rates are providing.

US determined to weaken the dollar?

For U.S. Treasury Secretary Timothy F. Geithner, a weaker dollar may now be in the national interest. The dollar has dropped more than 7 percent since Aug. 27, when Chairman Ben S. Bernanke signaled the Federal Reserve is prepared to ease monetary policy. Where once such a decline may have been met with resistance from the U.S., Geithner may now be tolerating it as a way of bolstering the recovery.

Higher stock prices in turn are bolstering consumer and business confidence. The danger is that the decline gets out of hand, fueling increases in the cost of living over the long term and prompting investors to avoid U.S debt.  As the dollar falls relative to foreign currencies, everything we export becomes less expensive to foreign consumers. So they buy more of our stuff, creating more jobs in the U.S. At the same time, everything they make costs us more. So we buy less from them and more from each other. Again, more jobs here at home.

Washington is actively pursuing a weak dollar as a jobs policy. (The dollar just plunged to a six-month low against the euro.) How? The Fed is keeping long-term interest rates so low global investors are heading elsewhere for high returns, which bids the dollar down. Every time another Fed official hints the Fed will start printing even more money (“quantitative easing” in Fed speak) the dollar takes another dive.

Meanwhile, Congress is ginning up legislation to allow the President to slap tariffs on Chinese imports because China is “artificially” keeping its currency low relative to the dollar. But using a weak dollar to create American jobs is foolish, for two reasons. First, no other country wants to lose jobs because its currency becomes too high relative to the dollar. So a weak dollar policy invites currency wars. Everyone loses.

At least a half dozen other countries are now actively pushing down the value of their currencies. Japan recently sold some $20 billion of yen in order to keep the yen down, the biggest ever sell-off in single day.  Brazil’s high interest rates are attracting global investors and pushing up the value of Brazil’s currency. This is crippling Brazil’s exports and fueling unemployment. Here’s the other problem. Even if we succeed, a weak dollar makes us poorer. Imports are around 18 percent of the US economy, so a dropping dollar is exactly like an extra tax on 18 percent of what we buy.

It’s no big accomplishment to create jobs by getting poorer.



Fed chairman says large banks must be shut down if they threaten financial system

WASHINGTON (AP) — Federal Reserve Chairman Ben Bernanke told a panel investigating the financial crisis that regulators must be ready to shutter the largest institutions if they threaten to bring down the financial system.

“If the crisis has a single lesson, it is that the too-big-to-fail problem must be solved,” Bernanke said Thursday while testifying before the Financial Crisis Inquiry Commission.

Bernanke is presenting his analysis of the crisis and views on potential systemwide risks as the panel approaches the end of its yearlong investigation into the Wall Street meltdown.

The Fed chief said bailing out these institutions is not a healthy solution and that great improvement will come from the new financial overhaul law. It empowers regulators to shut down firms whose collapse pose a broader threat to the system.

“Too-big-to-fail financial institutions were both a source … of the crisis and among the primary impediments to policymakers’ efforts to contain it,” Bernanke told the bipartisan panel.

“We should not imagine … that it is possible to prevent all crises,” he said. “To achieve both sustained growth and stability, we need to provide a framework which promotes the appropriate mix of prudence, risk-taking and innovation in our financial system.”

Bernanke led the economy through the financial crisis and the worst recession since the 1930s. The Federal Reserve took extraordinary measures to inject hundreds of billions into the battered financial system.

Last week he said the central bank is prepared to make a major new investment in government debt or mortgage securities if the economy worsened significantly.

Sheila Bair, the chairman of the Federal Deposit Insurance Corp., also is testifying at Thursday’s hearing. She says in prepared testimony “the stakes are high” for regulators to effectively exercise their new powers under the financial overhaul law. If not, “we will have forfeited this historic chance to put our financial system on a sounder and safer path in the future,” she says.