What's up with all this "Default" talk?

A lot of people are wondering about what will happen if the US defaults on its debt. The truth is that no one really knows with certainty all the consequences. These are a few I put together:

-          Fact: Both rating agencies (Moody’s and SP) would lower the rating of the US government from Aaa.

-          Fact: This rating change would make it more expensive for the US to finance everything it does. Since investors (China, Japan, private) would require more money for the added risk. So the US deficit would increase even more.

-          Fact: The rating agencies have said this downgrade would likely affect over 7,000 municipalities and states also making it more expensive for them to issue and finance debt.

-          Very likely: The impact on the global markets could be disastrous. The global financial system depends on Treasuries as the base investment vehicle for everything else (often used as collateral, retirement plans, other countries’ reserves, valuating risks, etc).

-          Very likely: There would almost certainly be a HUGE exit of all financial markets (stocks and bonds) as investors would have no place to go for safety (investors typically seek Treasuries under uncertainty). I would expect a 500-900, yes 500-900 drop in the Dow Jones the first day the default is clear (whether talks continue to fail or Congress votes the measure and unexpectedly fails to approve it).

Most republicans have refused to agree on raising the ceiling on principle. They say we need to deal with deficits now (in the middle of a weakening economic recovery). I agree that dealing with the deficit is key for economic growth going forward but I question the timing of it.

President Obama has come to the table trying to reach an agreement but so far those talks have failed. According to the Chicago Tribune, republican and House Majority Leader “Boehner acknowledge this week that more than 60 of his members were unlikely to support any deal”. Hard to govern or find any compromise going forward when these many members of congress refuse to cooperate in any kind of way.

Have a good weekend.

Rod Gonzalez
Fixed Income Strategist