Everything Changes in Global Financial Markets If There's a Credit- Rating Cut
Foley, Stephen, The Independent (London, England)
Less than three years after the collapse of Lehman Brothers, a second financial crisis is now more likely than not. Against the backdrop of calm equity markets and a positively sanguine bond market, I know this makes me sound like Chicken Little. But let me explain.
Successive statements by the two largest credit-rating agencies have made it much more likely that the United States government will have its credit-rating cut, regardless of whether the country's politicians agree to raise the debt ceiling before the money runs out on 2 August.
This week, even Barack Obama appeared to give up on getting a "big deal" to cut $4trn (2.5trn) from the federal budget. But on Thursday night, in what could one day be known as the shot heard around the world, Standard & Poor's suggested that a $4trn deal is the only thing that can prevent it cutting from its AAA rating on US debt. We should fear a downgrade of the US credit rating even more than we fear a US default on its debts. Few doubt there will be significant macroeconomic consequences from a downgrade: the US government will have to pay more for long-term debt in the future, interest rates will rise for businesses and families, and the world's largest economy could shift from weak recovery back into recession.
But the macroeconomic consequences, dire though they may be, are not what really scare me.
AAA-rated US Treasuries underpin trillions of dollars of financial transactions and the removal of that gold-plated rating, at a stroke, changes everything in global financial markets. It was these "micro" consequences, not the "macro" effects, that JPMorgan Chase's chief executive Jamie Dimon was talking about this week when he said: "No one can tell me with certainty that a US default wouldn't cause catastrophe."
Ben Bernanke, the Federal Reserve chairman, was talking about the consequences of a default when he predicted "possible chaos" in financial markets, but his words apply equally to a downgrade by the rating agencies. "Treasury securities are critical to the entire financial system. They are used in many different ways," he told Congress on Wednesday.
JP Morgan estimates that more than $4trn of Treasuries - nearly half of the outstanding stock - are used as collateral for the repo agreements that banks use as short-term funding and for derivatives trading through clearing houses and between banks. A downgrade from AAA implies at the very least that counterparties will have to tighten their terms, which could lead to financial distress for some borrowers and will certainly lead to a blizzard of dangerous rumours about who might be in trouble.
Worse, a lot of these transactions may require AAA-rated collateral, implying a collapse in demand for Treasuries and vast uncertainty in funding markets.
Pension funds and other …
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Publication information: Article title: Everything Changes in Global Financial Markets If There's a Credit- Rating Cut. Contributors: Foley, Stephen - Author. Newspaper title: The Independent (London, England). Publication date: July 16, 2011. Page number: 46. © 2009 The Independent - London. Provided by ProQuest LLC. All Rights Reserved.
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