Washington's wrangling over the debt ceiling may soon have some very real economic consequences. Banks are not amused, and they are preparing to reduce their Treasury buying in August if an agreement is not reached. This is a key point, because it shows that even if the U.S. does not default, "technical default" -- when the U.S. continues to pay interest on debt, but begins putting off other obligations due to too few tax revenues to cover everything it owes -- won't be a very pleasant situation for anyone involved.
Here are Michael Mackenzie and Aline van Duyn from the Financial Times reporting:
One strategy, which bank executives only agreed to discuss without attribution due to the political sensitivities related to discussing Treasury debt, is to have more cash on hand to put up as collateral against derivatives and other transactions, decreasing the financial system's reliance on Treasuries.
Currently, banks commonly use Treasuries as a source of collateral. If they switch to cash, then this will not be good for the government or the U.S. economy. First, it will mean that Treasury yields will begin to rises. That will make it even harder for the U.S. to afford its debt. Second, as the "risk free rate" that Treasuries provide begins to rise, other interest rates will follow. That will make financing more expensive for businesses and consumers, which should dampen economic activity.
And remember, all this occurs even if the U.S. never misses an interest payment -- Washington's prolonged bickering alone will accomplish this end.
Read the full story at the Financial Times.