The Washington Cat Fight has Consequences: US Debt Downgraded

Here is a bit from a post by Yves Smith (a pen name of Susan Webber, the Principal of Aurora Advisors, Inc., a management consulting firm) on her blog Naked Capitalism. This is the first of what will soon be a thundering herd of financial blows that will cost real Americans billions and trillions in lost wealth, lost jobs, lost economy, etc.:

Canary in the Treasury Coal Mine: Chicago Merc Increases Collateral Haircuts for Treasuries and Foreign Sovereign Debt

We had thought the authorities and the banks (no doubt with winks and nods from the Fed) would work to make sure that haircuts on collateral were maintained while the Washington game of debt ceiling chicken played itself out.

Either the Merc (more formally, the Chicago Mercantile Exchange) wasn’t on the distribution list or it decided not to play ball. It announced an increase in haircuts on Treasury and agency securities today (meaning Treasuries and agencies are now given less credit than before when posted as collateral). But it increased haircuts even more on foreign sovereign debt. This will force players who have been using any of these assets as collateral that are also pretty fully leveraged to either cut their positions or put up more cash or other collateral. But note the concern stated is “market volatility” rather than creditworthiness per se. ...

This is the first sign I’ve seen that looks troubling. The stock and Treasury bond markets have actually been pretty well behaved thus far (we saw vastly bigger one day moves in Tbond prices during the crisis, and the news on Friday was decidedly not pretty). My assumption has been that things would just be wobbly and not go critical until the Federal government started actually shutting operations and the gridlock persisted despite the howling from the public. But forced deleveraging feeding on itself could change that picture.

The financial system operates on leverage. The central bank backstopped players can probably be cajoled into not cutting repo haircuts to each other on Treasuries and agencies. But repo and collateral haircuts are a function not just of the collateral but who you are in relationship to your credit provider. For instance, the big prime brokers (Goldman and Morgan Stanley are over 60% of this market) increased haircuts on a lot of assets during the crisis to a degree where some hedge funds felt they were being abused (as in the increases were in excess of what even the rocky market conditions would buy, and some felt the dealers were trying to take advantage of them). Treasuries are also one of the biggest types of collateral for derivatives positions, and some may blow out if investors start shedding risk at the same time the collateral is worth less.

... this change is a sign that some parties are already starting to trim their sails as a precaution against rough weather.

It looks like the Republicans are going to get their wish: they are going to destroy what's left of the US economy... all as part of a ploy to get political "advantage". Shame!