July 12, 2011
No debt-limit deal? Your investments plummet
Commentary: It probably won’t happen, but if it did …
By Robert Powell, MarketWatch
BOSTON (MarketWatch ) — It’s no joke. The sky over the investment world and everything under it, including bonds, stocks, money markets, commodities, you name it, will fall unless lawmakers raise the $14.3 trillion Federal debt ceiling by Aug. 2.
It could be nothing less than catastrophic and worse than the financial meltdown of the late 2000s should Uncle Sam fail to raise the legal limit on government borrowing and default on U.S. debt, according to Greg McBride, a CFA charterholder and senior analyst with BankRate.com. “There will be no safe haven,” said McBride, from his perch in Florida.
In a press conference Monday, President Obama called for compromise as party leaders seek to craft a deal that raises the legal limit on how much the U.S. government can borrow while slashing projected deficits over the next decade. Democratic and Republican leaders held talks Sunday, but discussions broke down over taxes.
Obama said he would keep convening with party leaders every day until a debt-limit deal is reached. He also said he would reject a stopgap measure of 180 days or less. Congress has to raise the federal government’s legal debt limit by Aug. 2 or the nation could be in danger of defaulting on its debt, Treasury Secretary Timothy Geithner has said. A U.S. default could put the economy back into recession and create panic in global financial markets.
And the sad part is that most Americans (and lawmakers for that matter) don’t realize just how bad things will get if the U.S. fails to pay any of its obligations, even if it’s the teeniest, tiniest bill.
The crux of the matter, according to BankRate’s McBride, is that people on Main Street don’t understand the connection with, and the unintended consequences of, lawmakers not raising the debt ceiling.
According to McBride, here’s what’s likely to happen should the Obama administration and Congress fail to agree on a plan to raise the debt ceiling and compromise on deficit reductions over the next 10 years. “It’s not an uplifting conversation,” McBride said.
First, there will be what McBride calls a “rapid repricing” of all financial assets, not just Treasuries. In other words, the value of your 401(k) plans, IRAs, 529 plans, gold and real estate will all collapse.
And the reason for that is this: What is fundamental to the pricing of financial assets is the notion that U.S. Treasuries are risk-free. All financial assets are priced based on this assumption (or hope). If Treasuries are no longer risk-free, then all financial assets have to be repriced against another a benchmark.
And this time, investors won’t have a safe haven to which they can flock as they did during collapse of 2008. “There will be no place to hide,” said McBride. “Treasuries will no longer be safe in the event of a default.” Ditto real estate, gold, and farm land. In short, there will be no flight to safety because no asset will be safe. “Even cash might not be a safe haven.”
Credit crunch redux
Should Uncle Sam renege on its promises, McBride predicts that interest rates on all forms of debt — mortgages, car loans, government — will spike, resulting in a renewed credit crunch. Borrowing will come to a halt. Business will come to a halt. And even more troubling is the possibility that a halt in the flow of credit will cause commercial paper markets to dry up and that will result in a run on money funds.
Only this time, there won’t be a federal backstop like we had in 2008, said McBride. At the time, the Federal Reserve took action on several levels to support the money markets, and raised the insurance level on deposit accounts to $250,000 per person, per account category, per bank. But what if there was a run on banks? McBride said, “What good is FDIC insurance if the government is not paying its bills?”
If the scenario plays out, even in the case of a brief default, it will permanently tarnish the U.S.’s credit rating and usher in period of permanently higher interest rates. “There will forever be a risk premium attached to U.S. government debt,” said McBride.
Unemployment will rise
According to McBride, Uncle Sam defaulting on its debt could also result in massive job losses as companies slash expenses to conserve cash. And therein lies yet one more reason why lawmakers should do all they can to resolved the debt-ceiling issue. The U.S., which reported last week that unemployment rose to 9.2%, can’t afford any more bad news. “We’re in a bind and we can’t afford to raise the cost of borrowing,” said McBride.
Call, email your representatives
According to McBride, there is no safe place to put your money should Uncle Sam default. And the only good investment move to make right now just might be U.S. postage stamps on envelopes addressed to your representatives in Congress. And inside those envelopes should be requests, no — urgent pleas — asking lawmakers to deal with the debt ceiling now or run the risk of forever changing the landscape of the U.S. as we know it.