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UBS Explains What Happens If The US Is Downgraded Without A Default

Tyler Durden's picture


With increasing chatter that no matter what Congress agrees on, if anything, vis-a-vis the debt ceiling, the preemptive spin has begun, with the first salvo coming out of UBS' George Bory who has released a note "The difference between downgrade and default" which paints a very placid picture of the consequences of the US losing it AAA rating. Coming from a credit strategist, Bory naturally looks at the tightly confined consequences of such an event within the rates space exclusively without any mention of other cross-linked securities. In UBS' view, we would expect i) 10-yr yields rise 20-25bps, ii) a steeper yield curve, especially long end, iii) Treasuries underperform bunds and other highly rated sovereign debt iv) Vol term structure inverts further, v) Corporate spreads tighten, especially at long end, vi) Bank credit quality re-rated lower. Altogether not too bad. The problem is that there are a few trillion in money market related rating triggers which would grind to a halt the repurchase of paper of a sovereign that no longer has the AAA mark, resulting in our opinion in a dramatic crunch in short-term liquidity, and set the stage for a Lehman-like monetary system paralysis. But that is a topic for another day. Since today reality is to be ignored (see "transitory default"), here is why according to UBS America can simply call Moody's and S&P's bluff.

From UBS Daily Corporate Credit Snapshot

“The difference between downgrade & default”

Credit: USA - The difference between downgrade & default. “The budget should be balanced. Public debt should be reduced. The arrogance of officialdom should be tempered and assistance to foreign lands should be curtailed, lest Rome become bankrupt.” – Cicero

An actual default would occur if the US government misses one of its contractually obligated interest or principal payments. We, along with many other market participants, view the risk of an actual default as quite low. Indeed, even Congress recognizes the risk of default and appears to have a fallback strategy to allow the President to raise the debt ceiling to avoid a default in the event a broader deal fails to materialize. However, the sanctity of the US’s triple-A credit rating does not appear to be held in the same regard.

Two months ago, Moody’s fired a warning shot across the bow of the US’s triple-A credit rating when they changed their outlook to “ratings under review for possible downgrade” from “stable.” At the time they cited the looming debt ceiling debate as a possible stumbling block for the country’s rating. Last week Moody’s clarified and strengthened their position while S&P weighed in by placing the ratings on “CreditWatch with negative implications.” S&P went as far as to say there’s at least a one-in-two chance they will downgrade the US into the double-A category within the next 90 days if “Congress and the Administration have not achieved a credible solution to the rising U.S. government debt burden.” S&P quantified an agreement in the realm of “about $4 trillion” which could be “enacted and maintained throughout the decade” as a core achievement which would be key to affirming the AAA long term and A-1+ short term ratings of the U.S.

1) A long-term, credible deal which puts the US’s debt/deficit ratios onto a downward sloping trajectory; and

2) A change to the debt limit legislation mechanism. Threats of periodic payment interruptions are not a characteristic of an Aaa/AAA credit.

Based on recent comments out of Washington it doesn't appear as though either of those conditions are going to be met, thus raising the probability of a rating downgrade.

Do ratings matter? They do for some and not for others. S&P suggested they “may lower the long-term rating and affirm the short-term rating if they conclude that future adjustments to the debt ceiling are likely to be the subject of political maneuvering to the extent that questions persist about Congress's and the Administration’s willingness and ability to timely honor the U.S.'s scheduled debt obligations.” S&P's solution of downgrading the US’s long-term rating while affirming its short-term rating may provide some relief to investors constrained by rating guidelines.

If the US were avoid default, but have its long-term rating cut to ‘double-A’ while its short-term rating is affirmed at A-1+, then the impact on the fixed income market would be material but not catastrophic. We estimate that US Treasury 10-year yields may rise by as much as 20-25bp while the shape of the interest rate curve would likely steepen, particularly towards the long end of the curve. US Treasuries would also likely underperform the government debt of other highly rated countries, namely German Bunds. The term structure of volatility would likely invert further as the value of short expiries rises compared to long expiries, reflecting these near-term uncertainties. Corporate credit spreads may tighten as the perceived credit-worthiness of corporate America is viewed as improving while the government deteriorates. This is particularly true at the long end of bond curves where marginal changes in credit worthiness are felt most acutely. Finally, Financials, specifically Banks, are likely to suffer a re-rating by credit markets as a bank’s credit quality is rarely viewed better than its home country.

In short, and in quoting Julian of Norwich, "...All shall be well, and all shall be well, and all manner of thing shall be well" a saying, allegedly straight from god, which has become the motto of a crumbling centrally planned world.


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Thu, 07/21/2011 - 10:58 | 1477121 wsmith
wsmith's picture

I'm just not buying any type of U.S. downgrade.

We now live on a global plantation.  And the United States is the task-master.

The Bernank and Little Timmy have a lot of power.  They are gonna keep the balls in the air for a long long time.

But what the fuck do I know?

Anyway, so long.

And God bless all you Marxist cocksuckers. 

Thu, 07/21/2011 - 11:07 | 1477154 Spastica Rex
Spastica Rex's picture


Thu, 07/21/2011 - 11:46 | 1477314 augie
augie's picture

Does Guinness still come in packs of six? 

Thu, 07/21/2011 - 12:36 | 1477487 Buckaroo Banzai
Buckaroo Banzai's picture

Tyler, can we please stop referring to the failure of raising the debt ceiling as a "default".

Default means failing to pay the interest on your debt. The Feds collect WAY more than enough in taxes to pay the interest on our currently outstanding debt.

Thu, 07/21/2011 - 20:43 | 1479286 StychoKiller
StychoKiller's picture

Dammit Buckaroo, I'm a Doctor, NOT an Economist!

Decepticrats:  "There's income to re-distribute, we got NO time for spending cuts until AFTER the Economy improves!"

Republicons:  "There's Corporations hanging on by a thread, they need their welfare checks!  We got no time for tax increases until AFTER the Economy improves!"

SS Recipient:  "The Govt OWES me my money!"

Welfare Recipient:  "Obamatron will pay my mortgage and put gas in my car!"

General (Mayhem):  "Hey, soldiers don't fight for free!  Bullets cost dinero!"

CIA:  "Cut spending AFTER the Afghan opium crop is harvested!"

Someone really should mention that the biscuit wheels are coming off the gravy train!

Thu, 07/21/2011 - 11:22 | 1477218 trav7777
trav7777's picture

if a downgrade occurred, would this not dislocate the entire paper pyramid equating USTs with the AAA paper mandated for certain swaps?

I mean, wouldn't this trigger collateral calls all across every swap and repo spectra?  Would the Fed even be able to hold them or accept them as collateral at the window?

Thu, 07/21/2011 - 11:33 | 1477273 Cdad
Cdad's picture

Yes...I mean no...because this would only be a "soft downgrade" of US paper.

In any event, you are starting to see the answer on the 30 year, which was so obviously "jiggered" two days ago in order to dislocate traders and sew confusion.

Expect more talk about what will happen when the downgrade comes as the market attempts to "soften" the impact of the event by messaging expectations...because the downgrade is coming.

Thu, 07/21/2011 - 13:09 | 1477678 ElvisDog
ElvisDog's picture

I think a downgrade or default or whatever you want to call it would simply be ignored by TPTB. They would carry on business as usual.

Thu, 07/21/2011 - 11:45 | 1477310 Ripped Chunk
Ripped Chunk's picture

"But what the fuck do I know?"


Thu, 07/21/2011 - 11:01 | 1477132 Farcical Aquati...
Farcical Aquatic Ceremony's picture

Nothing will happen.  Absolutely nothing.  We live in a completely-controlled global "bio-dome".  It's 1984.  Atlas has shrugged.  And the largest global power is run by the Manchurian Candidate.  I never thought I would live to see the day where 80's Schwarzenegger films (Running Man, Total Recall) seemed plausible in my own lifetime.

Thu, 07/21/2011 - 11:09 | 1477166 Spastica Rex
Spastica Rex's picture

It's all Aldous Huxley to me.

Thu, 07/21/2011 - 11:13 | 1477181 Spastica Rex
Spastica Rex's picture

Oh, I didn't notice it before, but from your picture you look like you're being repressed.

Thu, 07/21/2011 - 11:30 | 1477261 Ripped Chunk
Ripped Chunk's picture

Bloody peasant

Thu, 07/21/2011 - 13:37 | 1477797 Farcical Aquati...
Farcical Aquatic Ceremony's picture

"Come and see the violence inherent in the system!"

Thu, 07/21/2011 - 11:01 | 1477134 jkruffin
jkruffin's picture

Just a matter of time before the bond, gold, and silver people figure out this ECB scam and the US scam, and send it all higher.  No way this euphoria on Wall Street is going to last.  It amazes me every day that goes by they keep getting away with it.  I guess it works, until it doesn't.

Thu, 07/21/2011 - 20:50 | 1479302 StychoKiller
StychoKiller's picture

From Mish's Global Economy:

Merkel, who calls the single currency a “work of peace” and part of Europe’s “uniting idea,” is the key holdout on so- called euro bonds.

“Once they look into the abyss of a major speculative attack on Italy,” Merkel will have to embrace euro bonds, Peter Bofinger, a member of the chancellor’s Council of Economic Advisers, said in a telephone interview. “That would be the turning point. There needs to be a joint guarantee for all outstanding debt.”

Political Union

France sees little room for a common bond without more integration of Europe’s fiscal and budgetary regimes, a French official said. German Deputy Foreign Minister Werner Hoyer said it will require a closer “political union.”


In other wordz:  "We're gonna hold the sword of Damacles over yer headz UNTIL we get a One-Europe Govt™ installed!


Thu, 07/21/2011 - 11:01 | 1477136 Dr. Engali
Dr. Engali's picture

Indeed, even Congress recognizes the risk of default and appears to have a fallback strategy to allow the President to raise the debt ceiling to avoid a default in the event a broader deal fails to materialize.


 I fail to see why congress wants to hand this guy more power. Is there anybody out there who is addressing the fact that this isn't even constitutional? Congress has the power of the purse strings. Not the administration. 

Thu, 07/21/2011 - 11:26 | 1477241 cosmictrainwreck
cosmictrainwreck's picture

can't get a fukin' DECISION by clusterfuck of 535 individuals, ergo defer to a single decision-maker. credit the pussies for their pragmatism

Thu, 07/21/2011 - 11:29 | 1477254 Dr. Engali
Dr. Engali's picture

So granting him dictatorial powers is the answer. And you cheer that?  I feel sorry for you.

Thu, 07/21/2011 - 12:23 | 1477445 cosmictrainwreck
cosmictrainwreck's picture

forgot the /sarc... and tongue-in-cheek - but still half-serious. fuck you and yer "feel sorry for". this pathetic on-shot situation is soooooo NOT fucking important in context of all the other bullshit swirling around. You worried about "dictatorial powers"? All he has do is sign Exec Order and send yer sorry ass to FEMA camp - that is if DHS hasn't already nailed you for violation of the Fucking Patiotica Americana Act and put  you in jail - sans habeus corpus.

Have a nice day 

Thu, 07/21/2011 - 11:01 | 1477138 Freewheelin Franklin
Thu, 07/21/2011 - 11:06 | 1477143 Re-Discovery
Re-Discovery's picture

Geitner to the market:

No AAA?  No problem.  Here, take my AA.  I mean how many A's does anybody really need.  I myself was a C student, and look where I am now.  Besides, A's are boring.  

I mean there are 25 more letters in the alphabet and we have pluses and minuses.  Brown University doen't even give grades anymore.  Grades are so 'Gold Standard'.  Not cool.

We're good for it . . . trust me.

Thu, 07/21/2011 - 12:31 | 1477473 Joe Sixpack
Joe Sixpack's picture

You can use one of my A's. Remember, when I worked at the IMF, I did not pay A penny in taxes. There AA for the US, plus my A, and you get AA+A=AAA ? Turbo Timmy math explained.

Thu, 07/21/2011 - 11:04 | 1477147 DougM
DougM's picture

S&P, Moody's and Fitch will not downgrade the US.

Thu, 07/21/2011 - 13:39 | 1477803 Farcical Aquati...
Farcical Aquatic Ceremony's picture

Correct.  First one to do so results in many employees being in plane crashes, drowning in hot tubs, and getting run over by cars with bad brakes.

Thu, 07/21/2011 - 11:07 | 1477156 Robslob
Robslob's picture

Roobslob Explains What Happens If The US Is Downgraded Without A Default


Thu, 07/21/2011 - 11:35 | 1477281 SheepDog-One
SheepDog-One's picture

In what?

Thu, 07/21/2011 - 11:59 | 1477353 Bohemian Clubber
Bohemian Clubber's picture

it d be more realistic explaining What Happens If The US Defaults Without A Downgrade

Thu, 07/21/2011 - 11:08 | 1477161 Shocker
Shocker's picture

So we win either way?

Thu, 07/21/2011 - 11:11 | 1477175 Ahmeexnal
Ahmeexnal's picture


Thu, 07/21/2011 - 11:18 | 1477195 Peter K
Peter K's picture

At least UBS is still reality based. That's a plus.

Thu, 07/21/2011 - 11:21 | 1477216 Johnny Lawrence
Johnny Lawrence's picture

UBS is in no way reality-based, believe me.  The cheerleading reports that come out of this firm are unbelievable.

Thu, 07/21/2011 - 11:37 | 1477287 Thisson
Thisson's picture



At least UBS is still reality based biased. That's a plus.

Thu, 07/21/2011 - 11:42 | 1477298 Ripped Chunk
Ripped Chunk's picture

You are joking right?

Thu, 07/21/2011 - 11:24 | 1477231 White.Star.Line
White.Star.Line's picture

As country after country is "downgraded",with their economies further ravished and their citizens impoverished, the people will look to their saviour, the central bank, for guidance and direction

Thu, 07/21/2011 - 11:26 | 1477239 Subprime JD
Subprime JD's picture

The problem is that there are a few trillion in money market related rating triggers which would grind to a halt the repurchase of paper of a sovereign that no longer has the AAA mark, resulting in our opinion in a dramatic crunch in short-term liquidity, and set the stage for a Lehman-like monetary system paralysis

Money market funds will not dump formerly rated AAA treasuries due to a downgrade to AA. There is simply no other place to put all these funds. Now if there was a downgrade to BBB or lower than that is a different story.

Thu, 07/21/2011 - 11:56 | 1477340 Insiderman
Insiderman's picture

Negotiable CDs maturing near-term might make an interesting substitute.

Thu, 07/21/2011 - 11:27 | 1477242 Pure Evil
Pure Evil's picture

S&P, Moody's and Fitch have years of experience with polishing turds, after all they knew how to put lipstick on those subprime mortgage pigs, didn't they?

Not to say the US rating turd needs any polishing, but for some reason it sure do stink around here.

Must be my stanky fingers.

Thu, 07/21/2011 - 12:16 | 1477420 Freewheelin Franklin
Freewheelin Franklin's picture

Got a little of the ol' stink finger, huh? Better than stink foot.



Thu, 07/21/2011 - 11:33 | 1477275 Yardfarmer
Yardfarmer's picture

UBS?!kind of like the fox checking up on the old henhouse.

Thu, 07/21/2011 - 11:38 | 1477289 SheepDog-One
SheepDog-One's picture

Default? Downgrades? To the US dollar which only has any value because its traded for oil? Ive seen worse its nothing but a flesh wound!

But your arms and legs are off!

Bah! Ive had worse!


Thu, 07/21/2011 - 11:43 | 1477302 FederalReserveB...
FederalReserveBankofTerror's picture

According to Gottfried Leibniz, we live in the best of all possible worlds. We are perfect monads. Our collective picaresque experience will result in the same conclusion Voltaire's  Candide came to after his collective life experiences, that we need to cultivate our gardens. There is about to be an explosion of picaresque life experiences for EVERYONE. may want to begin "cultivating your gardens" respectively.

Thu, 07/21/2011 - 16:16 | 1478535 rock11
rock11's picture

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Thu, 07/21/2011 - 17:47 | 1478832 AchtungAffen
AchtungAffen's picture

All Shall be Well. The Wars Will be Over Soon. Good Times Are Coming Back. We Just Went Around the Corner. AGW is a Lie. The USD Will be There For Ever. The Euro Will Crash With Its Union But Not The US. Guns = Law = Freedom. The Government Is Always The Problem. You Are a Communist.

Etc... The catchphrases with the most bullshit being spewed around lately...

Chile is a great country. But it's a very unequal country. Oh, lemme add one more phrase: "Inequality Doesn't Matter". Yeah, BS that too.

Do NOT follow this link or you will be banned from the site!