The Free Press, Mankato, MN

State, national news

October 7, 2013

A U.S. default seen as catastrophe dwarfing Lehman's demise

Experts see other markets being hobbled, economy hammered

(Continued)

Another depression was prevented only by unprecedented action by the Federal Reserve, which pumped $3 trillion into the financial system. The U.S. Treasury provided about $300 billion of capital for the nation's banks.

"If we miss an interest payment, that would blow Lehman out of the water," said Tim Bitsberger, a former Treasury official under President George W. Bush and now a New York-based managing director at BNP Paribas. "Lehman was an isolated company, and now we are talking about the U.S. government."

Buffett has asked politicians to stop using the debt limit as a weapon in policy debates. Morgan Stanley CEO James Gorman urged employees to contact their congressmen to remind them about the "unacceptable consequences" of a default.

"It should be like nuclear bombs, basically too horrible to use," Buffett, 83, said in an interview published by Fortune magazine last week.

One unexpected consequence of Lehman's collapse was the seizing up of the repurchase agreement, or repo, market — a form of secured, short-term borrowing used by Wall Street banks and investment firms. Many of Lehman's trading counterparts discovered the collateral they believed was backing their loans wasn't there to grab as rules allowed. That scared investors in the rest of the market, closing off other trades and leading to fire sales of securities and further price declines.

A government default could freeze the repo market more than Lehman's collapse because U.S. debt forms its backbone. At least $2.8 trillion of Treasuries serve as collateral for repo and reverse-repo loans, according to Fed data.

In the event of a default, Treasuries might no longer be eligible as collateral for repo agreements, according to James Kochan, Wells Fargo Funds Management's chief fixed-income strategist. The cheap funding for the holdings lowers the yields demanded on the investments, and unwinding the positions could amplify losses for lenders and borrowers.

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