Wednesday, October 16, 2013

Last Call For Steve Lonegan

Oh look, in a result that surprised precisely nobody, Cory Booker has beaten Steve Lonegan in today's special election for New Jersey Senate.

Can't imagine why voters would be angry at Republicans on today of all days, now can you.

Crisis Of Faith (And Credit)

Reuters economist Felix Salmon argues that if the negative consequences of a debt default would be lasting damage to the "full faith and credit of the United States of America" well, thanks to the GOP shutdown, we're already well into that scenario regardless of how this week turns out.

Right now, with the shutdown, we’ve already reached the point at which the government is breaking very important promises indeed: we promised to pay hundreds of thousands of government employees a certain amount on certain dates, in return for their honest work. We have broken that promise. Indeed, by Treasury’s own definition, it’s reasonable to say that we have already defaulted: surely, by any sensible conception, the salaries of government employees constitute “legal obligations of the US“.

Conversely, if you really do expect zombies to start roaming the streets the minute that the US misses a payment on its Treasury obligations, you’re likely to be disappointed. Yes, the stock market would fall. But the price of Treasury bonds would remain in the general vicinity of par, and it might even go up if Treasury announced that past-due interest would be paid on all debt at a statutory rate of 8% per annum. Even when it’s Treasury bonds themselves which are the instruments in default, Treasury bonds remain the world’s flight-to-quality trade, and the expected recovery on all defaulted Treasury obligations would be 100 cents on the dollar — or more.

The harm done to the global financial system by a Treasury debt default would not be caused by cash losses to bond investors. If you needed that interest payment, you could always just sell your Treasury bill instead, for an amount extremely close to the total principal and interest due. Rather, the harm done would be a function of the way in which the Treasury market is the risk-free vaseline which greases the entire financial system. If Treasury payments can’t be trusted entirely, then not only do all risk instruments need to be repriced, but so does the most basic counterparty risk of all. The US government, in one form or another, is a counterparty to every single financial player in the world. Its payments have to be certain, or else the whole house of cards risks collapsing — starting with the multi-trillion-dollar interest-rate derivatives market, and moving rapidly from there.

And here’s the problem: we’re already well past the point at which that certainty has been called into question.
So yes, you can make the argument that we're already into a "default" situation.  Right now Wall Street is counting on the situation getting fixed at near relativistic speeds.  Should that confidence run out, then the real damage begins.

How This All Shakes Out

Steve M. has a theory on the debt-o-rama endgame, and it's basically "this is only the beginning".  Ted Cruz will exact his pound of flesh by delaying a Senate vote into Thursday or Friday, and we have one of those "international economic whoopsie" things:

Somewhere in the period of Cruz's delay and the House GOP's threat to block the deal in that chamber, U.S. and global stock markets are going to go into free fall. These won't be irreversible plummets -- they'll just be a warning shot across Boehner's bow.

I think he'll respond then -- but I'm not sure. He's put his Speakership above all else so far. It may take more pressure from the business mainstream, either against Crazy Caucus members or on behalf of non-crazies. That kind of pressure seems slow in coming, but I think the prospect of default will concentrate minds.

So I think this will end -- for a few months. This is a short-term deal, after all. We'll be back in crisis again in a few months.

I'd like to think President Obama's demands that the hostage-taking stop, but the GOP is now fully vested in Obama Derangement Syndrome, so Steve is most likely correct.  There will be a "default" and Friday is going to be a miserable day for the markets, with the understanding that this will be "resolved" before Monday, one way or the other.

The practical upshot however is that barring a total meltdown by the GOP position, in January we'll most likely be right back at square one with the additional factor of more scheduled Pentagon sequestration cuts happening in the middle of the month.

Won't that be fun?


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