Monday, October 07, 2013 - Already Bankrupt

Already Bankrupt

by Sinclair Noe

DOW – 136 = 14, 936

SPX – 14 = 1676
NAS – 37 = 3770
10 YR YLD - .02 = 2.63%
OIL - .67 = 103.17
GOLD + 11.20 = 1323.40
SILV + .61 = 22.45

The markets gave up Friday's gains. The political dysfunction is hurting; right now it's just the economic uncertainty; that's a phrase I hate because businesses always face uncertainty but the shutdown and the looming debt ceiling are significant uncertainties. Let's start with the debt ceiling. Businessweek is describing it as “an economic calamity like none the world has ever seen.”

Here's the not so rosy scenario: “Failure by the world’s largest borrower to pay its debt -- unprecedented in modern history -- will devastate stock markets from Brazil to Zurich, halt a $5 trillion lending mechanism for investors who rely on Treasuries, blow up borrowing costs for billions of people and companies, ravage the dollar and throw the U.S. and world economies into a recession that probably would become a depression. Among the dozens of money managers, economists, bankers, traders and former government officials interviewed for this story, few view a U.S. default as anything but a financial apocalypse. “

Sure, if the US misses a payment it would be much bigger than 2008 because the US government is so much bigger and more interconnected than Lehman Brothers; and after the collapse of Lehman, the government stepped in to clean up the mess. Who cleans up the mess when the mess is the US government?

Warren Buffett says the politicians should not use the debt limit as a weapon in policy debates. From a Fortune magazine article last week, Buffett said: “It should be like nuclear bombs, basically too horrible to use.” Or as Senator Ted Cruz calls them: “Half measures.”

Just a reminder that in 2011, back when there was just a little talk about default without an actual default, just a hint, it wiped out $6 trillion of value from global stocks. Investors, structured vehicles, collateral agreements, derivatives contracts and other trading covenants have ratings-based rules that could force the replacement of Treasuries in a trade or portfolio.

Some people speculate it would push interest rates higher, others guess it might push rates down, but nobody knows for sure. The scarier scenario is that everything just freezes; it wouldn't matter whether rates are up or down because nobody can make a deal. Once the system starts to break down related to settlement and payments, then liquidity disappears.

Treasury Secretary Jack Lew has said the government will have only $30 billion of cash left by Oct. 17 to meet its commitments. Those can run as high as $60 billion a day, which means the Treasury will need to borrow more to meet its liabilities. The Treasury has $120 billion of short-term bonds coming due on Oct. 17.

About half of the US debt is held by foreign governments, central banks and other overseas investors. China is the largest holder of US Treasuries, with about $1.3 trilllion; they are not happy. A new idea is taking hold among House Republicans that perhaps breaching the debt ceiling isn't such a terrible idea after all. One form this takes is the patently absurd remarks of Rep. Ted Yoho (R-Fla.) who muses that "I think, personally, it would bring stability to the world markets." So, that's one politician who just certified he is insane.

A slightly less insane idea is to prioritize payments, but there are some problems with that: Treasury is not authorized to unilaterally decide to pay certain bills and not others. If it were, the constitutional order would completely collapse. Obama could just not cut the checks for farm subsidies or missile defense programs he opposes.  Because payment prioritization is illegal, Treasury's payment system is not designed to allow prioritization to happen. The systems "are designed to make each payment in the order it comes due." Of course systems could always be changed. But they can't just whip up an entirely new computer system in the next two weeks.

A German newspaper summed it up quite nicely: "At the moment, Washington is fighting over the budget and nobody knows if the county will still be solvent in three weeks," the paper concludes. "What is clear, though, is that America is already politically bankrupt."

As for the government shutdown, over the weekend the House voted to retroactively pay the roughly 800,000 furloughed federal workers; the measure still requires a Senate vote. So, the shutdown is no longer about expense because all the workers will be paid eventually; this just means that the government is not going to receive revenue, and that there will still be pain for the furloughed workers and the communities they live in. This has broken down to nothing but stupidity, plain and simple, with a side order of cruelty.

On Sunday, Speaker John Boehner’s talk hardened. He insisted he does not have the votes to get anything through unless the Democrats make concessions to get those measures passed. Obama has refused to do so. More worrisome, Boehner is changing his demands. Earlier, it was to delay implementation of Obamacare a year. Yesterday, there was no mention of Obamacare; the bone of contention was now out of control spending and debt. I’m not sure this is an actual change in position but in messaging, with the fight now moving to the debt ceiling.

And so today, President Obama made an unscheduled visit to the Federal Emergency Management Agency in his latest bid to draw attention to the effects of the government shutdown and to challenge Speaker John Boehner’s claim that he does not have enough votes to pass a measure to finance the government.

“The House should hold that vote today,” Mr. Obama said. “If Republicans and Speaker Boehner are saying there are not enough votes, then they should prove it. Let the bill go to the floor and let’s see what happens. Just vote. Let every member of Congress vote their conscience and they can determine whether or not they want to shut the government down. My suspicion is, my very strong suspicion is, that there are enough votes there.”

Turning up the pressure, Mr. Obama added, “The reason that Speaker Boehner hasn’t called a vote on it is because he doesn’t apparently want to see the government shutdown end at the moment, unless he’s able to extract concessions that don’t have anything to do with the budget.”

Chief Justice John Roberts and the Supremes will take the bench as scheduled today, ignoring the shutdown of much of the rest of the federal government. The Supreme Court has agreed to hear an array of cases of interest to employers and workers, manufacturers and financiers, and anyone else concerned about the intersection of commerce, law, and society.

The court today will hear arguments on whether federal securities law precludes certain class actions filed by investors who invoke state law. The case has added sizzle because it involves investors suing various defendants for losses related to R. Allen Stanford’s $8 billion Ponzi scheme. A lower court said that a federal statute, the Securities Litigation Uniform Standards Act, did not forbid state-law class actions in this context. 

Separately, the justices will resolve whether the corporate target of a state’s consumer-protection lawsuit can get the dispute moved from state court to federal court. The question sounds hyper-technical, but it matters. Defendants in consumer-protection cases prefer to litigate in federal courts, which are widely perceived as less plaintiff-friendly. This case involves Mississippi’s suit challenging alleged price fixing by manufacturers of flat-screen display panels. 

In recent years, the federal appeals court in Washington DC has issued a series of rulings making it difficult for the Environmental Protection Agency to curb power plant pollution that crosses state lines. The EPA is asking the Supreme Court to overturn a 2012 decision by the US Court of Appeals that struck down an agency rule that required upwind states in the East, Midwest, and South to reduce emissions of nitrogen oxides and sulfur dioxide to help downwind states meet national ambient air quality standards.

The Supreme Court refused to hear Argentina’s appeal of a lower court’s decision in favor of hedge funds that held bonds on which the country had defaulted. As is their custom, the justices offered no reasons for turning down the appeal. The appeal was from an interim decision last year from the United States Court of Appeals for the Second Circuit, in New York, and the justices may yet have an opportunity to consider whether to hear a separate appeal from the lower court’s final decision, issued in August. The case was brought by bondholders who were owed more than $1.3 billion and who refused to accept reduced payments after Argentina’s default in 2001. Most of the nation’s other creditors accepted such payments in later debt swaps. The Second Circuit ruled that Argentina had violated a contractual promise to treat all bondholders equally.

This case may actually set a precedent for US.