Slouching Toward Default, on Both Sides of the Atlantic

You'll have to pardon me.  I did mean to live blog this generation's Watergate hearings the second Dreyfuss trial Rupert Murdoch's fumbling appearance before British politicians, but I got distracted by less pressing events, such as the seeming stalemate over the US debt ceiling, and the ever widening gap between the bond spreads of Europe's center, and Europe's periphery.  I do eventually hope to get back to the real story of the day, but I hope you'll permit me this small digression.


William D. Cohan, whose House of Cards is required reading about the crisis, sums up the disquiet in global markets:
Here are the facts: The yield on Greek sovereign debt is now at record highs for the euro era. Last week's state-managed bond auction in Italy almost failed. And, while few seem to have noticed, the overnight repurchase market -- for short-term, secured, corporate debt obligations -- nearly seized up amid what Combs described as "an almost panicky scramble" for less- risky paper.

Indeed, investors' manic desire for safety last week reached levels not seen since the most acute days of the financial crisis in September and October 2008. Ironically, though, given the pathetic display in Washington and the country's ongoing fiscal troubles, people turned in droves to the perceived security of the U.S. Treasury market, even though it has never looked shakier.

. . . At the same time, it's an open secret on Wall Street that the Federal Reserve Bank of New York has become increasingly concerned about the state of U.S. money-market funds. With as little fanfare as possible -- understandably, so as not to cause a panic -- the New York Fed has been urging domestic money- market funds to reduce their exposure to European banks, where the funds have turned to increase yields not available in the U.S. because of rock-bottom interest rates.

The Fed is said to be terribly worried that -- because of provisions in the Dodd-Frank law -- it will no longer be able to rescue a money-market fund if it "breaks the buck," as the Fed did famously the day after Lehman Brothers Holdings Inc. filed for bankruptcy.

Neil Hume channels Harvender Sian:

Spain has entered the danger zone for yield levels. The chart below shows the yield moves in the constant maturity 10y paper for the GIIPS countries. These markets traded a range between 6 per cent and 7 per cent but ultimately this proved to be a pause before the move to higher yields then accelerated. There is no consistent yield trigger level inside this range but market talk of point-of-no-return around the 6 ½% is not without foundation either.

10-year-PIIGS-RBS.jpgGiven that Spain (and likely soon Italy) has entered this territory of yield levels we now believe that there is a growing risk that a large systemic risk event is plausible in the near term and if not then in a matter of weeks.

. . . The conditions for a near death experience for the Euro are in place now, which in turn should finally galvanise a more serious policy reaction. In the interim, risk assets can be crushed.
This, of course, assumes that the near-death experience will lead to "a more serious policy reaction", rather than, say, death.  I'm rather skeptical.  On Sunday, the FT's Quentin Peel had Angela Merkel warning that 

. . . she will only attend an emergency summit on the eurozone financial crisis in Brussels on Thursday if there is going to be an agreement on a new rescue plan for Greece.

She insisted on Sunday that she wished to avoid any Greek debt rescheduling, but underlined that the key to a deal would be substantial voluntary involvement of private creditors in easing the Greek debt burden.

There are just two small problems with this.  The first is that the credit ratings agencies have announced that they will view any voluntary restructuring as a default--as they should, because voluntary or not, Greece would still be arranging to pay less than they owe.  And the second is that, as Peel points out, the European Central Bank has announced that it cannot accept defaulted securities as collateral.  So getting a voluntary deal just means that other Euro-members are going to have to bail out the Greek banking system, which will no longer be able to use its sizable collection of Greek government bonds to tap the ECB.  I assume that Merkel understands this . . . but I can't really see much foundation for my assumption.


As Kevin Drum points out, "This is not, repeat not, a good time to be screwing around with the possibility of defaulting on U.S. debt".  Yet as Stan Collender notes:

On the one hand, much of Wall Street is insisting that the whole fight is political theater and that Congress and the White house will work something out. On the other hand, congressional Republicans are insisting that Wall Street won't react negatively if a deal doesn't get done.

In other words, financial markets aren't yet reacting because they think a deal is in the offing and the GOP isn't cutting a deal because it doesn't think Wall Street cares.

I'm having a hard time seeing how any of this ends well.

Presented by

Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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