Treasuries are widely used as collateral for cash loans in the repurchase, or repo, market. On Friday, the Securities Industry and Financial Markets Association held a meeting with staff from the big banks to discuss operational issues that could arise in the event of a default.Folks, this is not a game. The US Treasury market is the backbone of international finance. To let the US get this close to default is beyond irresponsible.
Analysts at Bank of America Merrill Lynch estimate 74 per cent of primary dealer repo financing, about $2,100bn, involves Treasury collateral. Money market funds also place significant amounts of cash in the repo market, and a default scenario would create strains for this sector if investors start to pull out their cash.
A downgrade of Treasuries from their triple A or haven status could well ripple through the financial system. “I think people view that as a risk, I know for a fact that we do consider it a risk in terms of all financial assets”, said Rick Rieder, chief investment officer for fixed income at BlackRock.
Modern financial theory starts from the premise that there is a risk-free rate of return available, backed by the “full faith and credit” of the world’s superpower. It is the reference point for pricing other assets.
However, practical consequences would soon follow a downgrade. Investors who had lent cash against Treasuries as collateral on the loan would require more bonds to back the loan. Such a move would in effect force borrowers to cut their trades and spark a deleveraging wave through markets, as was seen in the wake of Lehman Brothers filing for bankruptcy in September 2008.
Tuesday, July 19, 2011
For Those of You Who Think A Default is "No Big Deal"...
There are people who are telling us that a US default would be "no big deal." To those people, I would offer the following: