“Once more unto the breach, dear friends, once more;
Or close the wall up with our English dead!
In peace, there ’s nothing so becomes a man,
As modest stillness and humility:
But when the blast of war blows in our ears,
Then imitate the action of the tiger;
Stiffen the sinews, summon up the blood.” Henry V, III (1)
What is a default?
A default is a default, is a default: “failure to fulfill an obligation, esp. to repay a loan or appear in a court of law.” Or, “The omission or failure to fulfill a duty, observe a promise, discharge an obligation, or perform an agreement.” [Black’s] That’s it. Once an obligation is not met, once a loan payment has not been made, once part of an agreement has not be performed — there is default. There are no little defaults, middling defaults, or big defaults.
What are the consequences of default? If a person defaults on a student loan the school, the financial institution holding the loan, and the federal government may all take action to recover the money owed. A person who has defaulted may experience difficulty signing up for utilities, getting a cell phone plan, or passing a credit check for almost any financial transaction. An individual may negotiate with a lender to repay a loan, but the loan is still a binding legal document.
There was some talk of “strategic defaults” in the wake of the Financial Debacle of 2007-2008. Homeowners followed this advice at their peril. Bankrate describes three of the consequences, and none of them are good. The person’s credit rating will be wrecked, there will be extreme difficulty getting another mortgage, and in some instances there are tax liabilities involved.
The same misery accompanies default on auto loans — repossessed property, wrecked credit, and the inability to secure future lines of credit.
If we are clear that a default is a default, and defaults have serious and obnoxious consequences, then why would any person with a lick of common sense believe that a national default wouldn’t be a serious and dangerous action?
Remember all those members of the right wing chatterati who railed against those irresponsible borrowers who bought houses they couldn’t afford and brought pain and suffering to those poor innocent bankers? If those families were castigated for their irresponsibility and their failure to meet their obligations, then what are we to think of those who are now advising the federal government not meet its obligations?
A Default is NOT a Deferment
A deferment is a completely different beast than a default. A person, caught in a financial bind, may negotiate with his or her creditors for a deferment on payment, and if the two sides can hammer out an agreed upon solution the obligation may be deferred — but not eliminated. Some members of the Congress are sounding like they think the U.S. government can “prioritize” its payments — rather like a person can hold off paying one bill until the next pay check, or as a person might make the mortgage payment but get a deferment on the car loan. Sovereign governments are not financed this way.
The Government and the Bond Market
The United States government does not take out loans. The Chinese have not made any loans to us. Nor the Caribbean bankers, nor the British, nor the Germans, nor the French, nor anyone. The Chinese, the Japanese, the Caribbean banks, the British… invest in the United States by purchasing Treasuries.
Treasuries are bonds, and bonds are:
“A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities.”
There are short term bonds and long term bonds, they range from 90 days to 30 years, and each comes with a statement of the interest rate (coupon) and the date at which the bond matures. The better the quality of these bonds (the less risk of default) the lower the interest rate demanded by customers for the bonds.
At this point we run into another problem for the Default Deniers: What to do with the bond-holders? Which bond-holders? Bonds are maturing every day. Interest is due on bonds usually every six months. If a person holds a 30 year Treasury bond then interest is automatically paid into his or her bank or brokerage account every six months. The government doesn’t cut checks for interest payments.
Treasury bills, bonds, and notes are are all marketable securities. A Treasury bill is a short term transaction for one year or less, and because they are short term they don’t pay any interest until maturity. A Treasury notes are also short term, ranging from 2 years to ten years, and Treasury bonds are longer term, beginning at 10 years and ranging up to 30. And, there are lots of them:
“The amount of marketable U.S. Treasury securities is huge, with $8.85 trillion in outstanding bills, notes, and bonds as of the end of 2010. Trading volume in Treasury securities averaged $949.8 billion a day in 2010.” (emphasis added)
That’s right — $949.8 billion PER DAY. Now, who was saying that it would be “easy” to have the U.S. Department of the Treasury reschedule electronic payments of interest and handle more than $949.8 billion or more in trading volume PER DAY? There’s a reason the financial news anchors don’t talk about Treasury “transactions,” they talk about Treasury “volume.”
What’s tied to the Treasury Bonds?
Lots of stuff. Some of it better than others. For example, the rate on a home mortgage is tied to the 10 year and 30 year Treasury yields. Bond yields go down, and interest rates on bonds go up in an inverse relationship. Or, put even more simply — if the interest on a 10 yr. Treasury goes up, so does the cost of your 10 yr. loan. Interest rates go up on a 30 year bond, so does the cost of getting a mortgage. We know from experience that when home mortgage loans are more expensive the housing sector tends to stall.
Remember all the flap about the Student Loan bill signed into law by President Obama last August? The interest rate on student loans is now tied to the interest rate for 10 year Treasuries. Supposedly because these are nice, safe, low-risk government securities. Therefore, if the interest rate on those 10 year securities has to go up to entice buyers spooked by default noises, what happens to student loan costs? (You only get one guess.)
What else is tied to the Treasuries? Just some not-so-minor details like the calculations involved in determining the Gross National Product, the Consumer Price Index, and the Producer Price Index. If we start tacking that “default premium” onto the costs associated with U.S. Treasuries, all manner of dominoes start to fall into each other.
Because U.S. Treasuries are supposed to be the safest investment on Planet Earth, they are used as Tier One collateral, the best capital in the bank; the core of the banking system. If we thought the freeze after Lehman Brothers collapsed was a beauty, the potential collateral damage to the financial sector in a government default is described by Warren Buffett as a nuclear bomb. What would make one of the world’s Super Investors use that kind of language? The answer lies in the hard fact that there is at least $2.8 TRILLION worth of U.S. securities out there which are serving as collateral for those repo and reverse repo loans on which Wall Street is dependent.
The next time some Congress Creature blithely observes that the federal budget and financing system is “just like your family budget,” ask if there’s $2.8 trillion worth of family marketable securities out there underpinning the economy?
Stiffen the Sinews
In short, this is why the Financial Services Forum, and Goldman Sachs, are ready to “imitate the actions of the tiger,” and “stiffen their sinews.” The central nature of the U.S. Treasuries is such that the IMF, and the Chinese and the Japanese, have weighed in on the prospect of a U.S. default.
The previously unthinkable has become a political equivalent of a loaded firearm, pointed directly at the heart of the American economy, held by individuals who in light of their own statements show little, if any, understanding of the disastrous consequences of pulling the trigger. It’s high time to decide the only blood involved is going to be that summoned up by the adults in the room.