Banks, Hedge Funds Threaten A Repeat Of Lehman If Debt Ceiling Not Raised

Tyler Durden's picture

As we reported yesterday, The Treasury Borrowing Advisory Committee, easily the most important 3rd party advisory structure at the US Treasury currently, chaired not surprisingly by JP Morgan and Goldman Sachs, released a letter to Tim Geithner, doubling up his calls for untold death and destruction, not to mention plunging year end bonuses, if the US is not allowed to kick the can down the road for another 1-2 years. For those curious, in addition to the Matt Zames chaired committee, other members include Soros, Tudor, Bank of America, BNY, Moore, Alliance Bernstein, Morgan Stanley, Round Table IMC, Brevan Howard, PIMCO (lol), Dodge & Cox, RBS, and Western Asset Management. The full M.A.D. letter is presented below.

The Honorable Timothy Geithner
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

Dear Mr. Secretary:

As Chairman of the Treasury Borrowing Advisory Committee, I am writing to express my concerns regarding the urgent need to increase the statutory debt limit. A considerable degree of uncertainty already exists among market participants given the severe and long-lasting impact that even a technical default would have on the U.S. economy.

Any delay in making an interest or principal payment by Treasury even for a very short period of time would put the U.S. Treasury and overall financial markets in uncharted territory, and could trigger another catastrophic financial crisis. It is impossible to know the full impact of such a crisis on overall economic growth and on Treasury’s financing costs. However, the lessons from the recent crisis suggest that several damaging consequences will likely result, ultimately raising Treasury’s long-term funding costs and increasing the burden on the American taxpayer. These consequences stem from five developments that could likely occur if Treasury were to default on its obligations as a result of a failure to raise the debt limit in a timely manner.

First, foreign investors, who hold nearly half of outstanding Treasury debt, could reduce their purchases of Treasuries on a permanent basis, and potentially even sell some of their existing holdings. A worrisome precedent is the sharp decline in foreign sponsorship of [government-sponsored enterprise, or G.S.E.] debt since Fannie Mae and Freddie Mac were placed under conservatorship. Despite assurances from Treasury officials regarding the U.S. commitment to these institutions, foreign sponsorship has yet to return to pre-conservatorship levels. If foreigners began curtailing their investment in Treasuries as a result of a default, Treasury rates, and thus Treasury’s borrowing costs, would undoubtedly rise. A sustained 50 basis point increase in Treasury rates would eventually cost U.S. taxpayers an additional $75 billion each year.

Second, a default by the U.S. Treasury, or even an extended delay in raising the debt ceiling, could lead to a downgrade of the U.S. sovereign credit rating. Indeed, Standard and Poor’s decision to change the U.S. ratings outlook from stable to negative this week indicates a one-in-three chance that Standard and Poor’s will downgrade the U.S. rating within the next two years. One reason cited for the change in the outlook is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges. It is possible that a default, or even a delay in acting on the debt ceiling, will be perceived as an increased indication of the political inability to forge a compromise on essential long-term fiscal reforms. The consequences of a ratings downgrade would be significant, with the potential for Treasury rates to rise by a full percentage point for each one-notch downgrade.

Third, the financial crisis you warned of in your April 4th Letter to Congress could trigger a run on money market funds, as was the case in September 2008 after the Lehman failure. In the event of a Treasury default, I think it is likely that at least one fund would be forced to halt redemptions or conceivably “break the buck.” Since money fund investors are primarily focused on overnight liquidity, even a single fund halting redemptions would likely cause a broader run on money funds. Such a run would spark a severe crisis, disrupting markets and ultimately necessitating the same kind of backstops that Treasury and the Federal Reserve initiated in the aftermath of the 2008 crisis. Such further increases in Treasury’s off-balance-sheet commitments are likely to be viewed negatively by investors and ratings agencies, which will potentially put further downgrade pressure on U.S. sovereign ratings.

Fourth, a Treasury default could severely disrupt the $4 trillion Treasury financing market, which could sharply raise borrowing rates for some market participants and possibly lead to another acute deleveraging event. Because Treasuries have historically been viewed as the world’s safest asset, they are the most widely-used collateral in the world and underpin large parts of the financing markets. A default could trigger a wave of margin calls and a widening of haircuts on collateral, which in turn could lead to deleveraging and a sharp drop in lending.

Fifth, the rise in borrowing costs and contraction of credit that would occur as a result of this deleveraging event would have damaging consequences for the still-fragile recovery of our economy. In 2008, placing the GSEs in conservatorship combined with a tightening of credit standards caused mortgage spreads to widen by 1.5 percent, ultimately raising mortgage rates for consumers. A similar rise in mortgage and Treasury rates would adversely impact economic growth, potentially pushing the U.S. economy back into recession.

Finally, I would emphasize that because the long-term risks from a default are so large, a prolonged delay in raising the debt ceiling may negatively impact markets well before a default actually occurs. This is because investors will likely undertake risk-management actions in preparation for a potential default. For example, borrowers who rely on short-term funding markets, including the GSEs, may attempt to pre-fund themselves or hold excess liquidity through July, distorting money market rates. Additional effects could include large auction concessions, especially if Treasury were forced to delay auctions for cash management purposes. I would also expect to see weaker demand for Treasury securities as uncertainty increases on whether the debt limit will be raised. Both of these effects would negatively impact Treasury’s borrowing costs.

Given the magnitude of the adverse consequences a default would have on Treasury borrowing costs and the health of the broader economy, action is urgently needed to increase the statutory debt limit. Swift action would also help ease the existing uncertainty in financial markets that could begin translating into real market impacts well before Treasury exhausts extraordinary actions at its disposal to postpone a default. Notwithstanding your significant efforts to date, your continued attention to this important issue is greatly appreciated.


Matthew E. Zames
Treasury Borrowing Advisory Committee

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JLee2027's picture

Since default is inevitable, better now rather than later.

I pray we have 218 brave men and women in the House of Representatives willing to stand up and say "No More".

Quintus's picture

It's a nice thought, but seriously.....

anynonmous's picture

Well Zames is clearly the right guy for the job, he clearly knows a Ponzi when he sees one.  He was one of three JPM executives named in a court filing (PDF) for having known about the Madoff Ponzi, though in that case they are accused of taking no action.

From the filing (Dec 2, 2010):

“For whatever it[’]s worth, I am sitting at lunch with Matt Zames who just told me that there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a [P]onzi scheme.” (June 15, 2007)


The story has been told time and time again how Madoff duped the best and the brightest in the investment community. The Trustee’s investigation reveals a very different story—the story of financial institutions worldwide that were keen to the likely fraud, and decidedly turned a blind eye to it. While numerous financial institutions enabled Madoff’s fraud, JPMC was at the very center of that fraud, and thoroughly complicit in it.

Manthong's picture

Old Charlie stole the handle and the train it won't stop going, no way to slow down.

DavidC's picture

Great track, from one of the earliest albums I got into.


Weisbrot's picture

until the incompetence and or corruption is allowed to fail the entire nation suffers.

dizzyfingers's picture

Where's that "perfect ten" button?!

ParaZite's picture

Sadly, The reality is we just have 218 well paid criminals in the House...just like the rest of our criminal, corporatocratic government. 

AmCockerSpaniel's picture

You are so right.    


The voter is damned if he does, and damned if he does not. They are all bought and paid for.

IBelieveInMagic's picture

This is a crock of shit -- the fact is that the voter has been happy to have someone else (Congress, etc.) enable voters living beyond our means and allow us the deniability when things go bad. We are all complicit.

This worked in the short run because we were able to consume at the expense of the rest of the world (on borrowed dime that will not be paid back) but now that run is coming to an end. 

JLee2027's picture

We consumed at the expense of the rest of the world? Hardly true. And you forget we have provided a security umbrella for the West and the Pacific area for the past 65+ years. We do not "owe the world". In fact, our consumption raised living standards worldwide.


Bicycle Repairman's picture

"we have provided a security umbrella for the West and the Pacific area for the past 65+ years"

The demand for that protection ended with the fall of the USSR.  We got the memo, but refused to read it.

Hacksaw's picture

Obviously you haven't been reading about how the Aussies have been wringing their hands about how they want the U.S. to get in between them and China. You're kidding yourself if you think there wouldn't be a wailing and gnashing of teeth if the U.S. brought all their troops home.

falak pema's picture

WE are to blame it on the Boomer generation that elected Clinton and GWB. Sixteen years...Some people say a man is made outta mud...

A poor man's made outta muscle and blood
Muscle and blood and skin and bones
A mind that's a-weak and a back that's strong

You load sixteen tons, what do you get
Another day older and deeper in debt
Saint Peter don't you call me 'cause I can't go
I owe my soul to the company store...


dizzyfingers's picture

I'm never going to vote again because I think elections are a crock and nothing every really changes because voting simply says "yes, let the corruption and swindles continue", but probably the reality is this: we're all more or less stuck with this country, and our citizenship is sort of like being on a rogue train as it rumbles downhill out of control. What is the titizen-passenger supposed to do? Climb out the train window and somehow get to the engine so that he or she can jump in front of the train to stop it? How's that going to work out? But what else is there, since there's no access to brakes, and once on its downhill trip, brakes won't work?

We're more-or-less stuck with the country we're born in.

What's your detailed idea of a plan that would work?

Sudden Debt's picture

They have been allowed to behave the way they do these last few decades when the presidents decided to sell the US to the happy few.

It's like giving a lighter to a kid, watching him put the place on fire and when the fire is on for an hour saying: BAD CHILD! YOU CAN'T PLAY WITH FIRE!

The reactions are way to late. They should have been shot a decade ago.

What can you do now? Is there still anything left to save?



dizzyfingers's picture

Thanks. Truth emerges slowly and painfully, but it emerges.

cossack55's picture

Hey, we just had the Easter Bunny. 218? I'll settle for 3.

let-them-eat-cake's picture



Laugh out loud or man drowning?

poggi's picture

...and, when every indiviudual saver's government-backed money market fund goes to zero value, will you handle the blowback?

Ruffcut's picture

Brave representatives?

THat's just plain funny. Surprised they did not design the capitol building to look like a huge vagina.

Weisbrot's picture

damn straight, they had tarp 1, tarp 2, tarp 3, talf, qe1, qe light, qe2 ... the system should have flushed out the crap in 2008, it was not permitted to do so,  it needs to fush out the crap now!

dizzyfingers's picture

I agree, but I don't think anyone who's brave is in Congress.

Landrew's picture

Why the pretense? A Ponzi is a Ponzi whether it's 15 trillion or 50 trillion!

Again, please help get this video to physics students in Japan, thanks.

HamyWanger's picture

I don't see the problem you have with Goldman Sachs and JP Morgan. If they were 'evil zionistas' who don't produce value, like bigot libertarians say, they would not make so much money (as every financial contract is based on law and mutual consent), and Americans would not vote every 4 year for a member of the current ruling elite if they were not satisfied. So having GS and JPM in the board of economic advisors is a healthy measure, as we can profit from their expertise. 

Raising the 'debt limit' is just common sense. No one, even lunatic silverbugs, want to see what would happen if it is not raised. 

Moe Howard's picture

Why are you using the American flag as a avatar when the Coat of Arms of the Rothschilds would be more accurate?





<HELP> for explanation.

cossack55's picture

I think it has 57 stars on it.

Cash_is_Trash's picture

Those seven are:

Iraq, Afghanistan, Bahrain, Canada, Cancun, Libya...

Help me out people!

JLee2027's picture

...and Kenya and Indonesia. Just to cover all the possibilities of BO's citizenship issues.

falak pema's picture

You forgot Israel and Saud Arabia the biggest lodestone north starrrrrrrrrr!

Sam Clemons's picture

Harry, under a value-based gold or silver system, with no one setting interest rates and no central credit creation, I would expect GS and JPM to not exist. 

It would be hard to not make money when you can borrow at .25% and loan the dollars you just created under fractional reserve banking to the broke ass government and citizens at 4% and 14% respectively. And if and when those bets go south, you get bailed out.

The whole thing stinks.  If the economy can't grow except when it takes on more debt, then that should be a glaring problem.  The whole concept of growth is a lie in a fixed world, and is only based on borrowing from the future:  banks create money out of thin air, and our posterity must pay them for the right to use it now.  I don't see value supplied here.

SoNH80's picture

Expertise in raping the fisc more like it.  *Nausea*

Narrow Ledge's picture

And if the debt ceiling is raised... it's all good?  This is a lose/lose everyone

smlbizman's picture

i promise you that this letter was written by turbo timmy ....

cossack55's picture

I was not aware TurboTax had a word processing component.

Old Poor Richard's picture

Dumbass Keynesians keep arguing that there's no analogy between the US borrowing and going gonzo on credit cards, yet here we have gangster banks sending threatening letters to the Jeethner that rings true to anyone who's been prodded by thug credit card lenders.

When your last credit card is maxed out, what do you do?  Apply for another one and head over to Needless Markups for a new handbag to try out the card!

Just like credit card companies that threaten you for "inactivity" on your account, these guys are instructing the US with a National Lampoon cover style threat: you had better keep borrowing [so that we can keep skimming], or we're going to shoot your economy.


Corduroy's picture

Yes, but secretly they cannot wait to raise interest rates...

MyFriendMises's picture

They are not dumbasses.  They are criminals using the guise of Keynesian Economics to conceal their true intentions of the continued transfer of wealth from the middle class to the rich.  When the transfer has been completed and the middle class has jumped back into the market and bought out the TPTB stake they will let the market collapse and will raise interest rates. 


It is very dangerous to write people off as stupid when what their actions do not coincide with logic.  They are usually very smart but just don't live with the same moral code as the rest of us.  We mistakenly believe that people (i.e. Bankers and Politicians) will in end do what is good for the masses when in fact they are continuing to do what is good for them.

overmedicatedundersexed's picture

the banks are holding a gun to their collective heads and saying do it or we shoot.. I say shoot.

earnulf's picture

Why does the sheriff scene in Blazing Saddles come to mind?    Especially the statement he makes once he is safe in the sheriff's office.....

wandstrasse's picture

they will let the market collapse and will raise interest rates. 

THEY will let the market collapse and introduce a PM standard when THEY loaded up enough PMs in their vaults. THEY have at least 75% of all PMs on the planet BEFORE they let the fiat system collapse.

sunnydays's picture

I hope Congress doesn't play the game and calls their bluff.  Congress held with the first TARP vote and voted no, then they were threatened with martial law if they didn't pass it.  I have no doubt that another martial law threat will be given to them if they don't do as the banks want.


The junior Congress people are being lobbied by every banker there is and they are being told to raise the limit.  But I hope the tea baggers and all the others will hold out and not do it.  But I know, they will fold to the banks and raise the limit, they always do what the banks want. 


I can just imagine the type of threats they are getting.

cossack55's picture

The difference is if you made similar threats you would soon be doing the perp walk.  Land of the Fee and Home of the Slave.

cowpieflapjack's picture

Funny shit right there...


Ruffcut's picture

Yep, I don't care who you are. ++

Lord Welligton's picture

Land of the Free home of the Knave.

cossack55's picture

Knave? Too freakin' English. We's don't be's talkin' no English here in amerika, ya big dumb Limey.

Lord Welligton's picture

Humble apologies my good sir.

Moe Howard's picture

Just say NO to more debt.

I did that in my life years ago.

Time for us to say the same as a country.

Whatever TBTF wants, we need to do the opposite.