What Happens When the US Banks Take a Hit On Their Senior-most Assets? Pt 2

Phoenix Capital Research's picture

This is a continuation of yesterday’s essay concerning what will happen to the US banks when Treasuries lose their AAA status. The short answer is: KA-BOOM, based simply on the fact that Treasuries are the senior-most assets against which banks lend.


To understand what I mean by this, you first need to understand the Primary Dealer system behind the Federal Reserve banks.


If you’re unfamiliar with the Primary Dealers, these are the 18 banks at the top of the US private banking system. They’re in charge of handling US Treasury Debt auctions and as such they have unprecedented access to US debt both in terms of pricing and monetary control.


The Primary Dealers are:


1.     Bank of America

2.     Barclays Capital Inc.

3.     BNP Paribas Securities Corp.

4.     Cantor Fitzgerald & Co.

5.     Citigroup Global Markets Inc.

6.     Credit Suisse Securities (USA) LLC

7.     Daiwa Securities America Inc.

8.     Deutsche Bank Securities Inc.

9.     Goldman, Sachs & Co.

10. HSBC Securities (USA) Inc.

11. J. P. Morgan Securities Inc.

12. Jefferies & Company Inc.

13. Mizuho Securities USA Inc.

14. Morgan Stanley & Co. Incorporated

15. Nomura Securities International Inc.

16. RBC Capital Markets

17. RBS Securities Inc.

18. UBS Securities LLC.


These are the firms that buy US Treasuries during debt auctions. Once the Treasury debt is acquired by the Primary Dealer, it’s parked on their balance sheet as an asset. The Primary Dealer can then leverage up that asset and also fractionally lend on it, i.e. create more debt and issue more loans, mortgages, corporate bonds, or what have you.


Put another way, Treasuries are not only the primary asset on the large banks’ balance sheets, they are in fact the asset against which these banks lend/ extend additional debt into the monetary system.


So if the US defaults or loses the AAA rating on its Treasury debt, the impact will be severe for the large banks. It will affect lending both to the public and between the banks themselves. And it will also trigger massive margin calls.


Which is why the White House is telling the banks that the US won’t default behind the scenes:


While officials from the Obama Administration raised their rhetoric over the weekend about the possibility of a debt default if the debt ceiling isn't raised, they privately have been telling top executives at major U.S. banks that such an event won’t happen, FOX Business has learned.


In a series of phone calls, administration officials have told bankers that the administration will not allow a default to happen even if the debt cap isn't raised by the August 2 date Treasury Secretary Tim Geithner says the government will run out of money to pay all its bills, including obligations to bond holders. Geithner made the rounds on the Sunday talk shows saying a default is imminent if the debt ceiling isn't raised, and President Obama issued a similar warning during a Friday press conference after budget negotiations with House Republicans broke down.


Make no mistake, something big is afoot behind the rhetoric and political talking points being thrown around by the White House and the GOP. That something will be some means of letting the banks get through this period without getting crushed.


Remember just who helped get Obama in office in 2008:


Top Obama Donors ‘08


University of California


Goldman Sachs








JP Morgan



Obama ran on a platform of Change, but as his actions have shown since election (the day after his election he put two Citigroup executives on his economic transition team). These are the folks who got him in office (the Finance industry accounted for over $24 million of fundraising for Obama). And they’re the folks whose economic interests he takes to heart the most.


The same goes for Congress, which received over $37 million in donations from Commercial Banks in the 2008 elections.


Total Donations

Donations to Democrats

Donations to Republicans

% to Democrats

% to Republicans

$37.5 million

$17.9 million

$19.5 million




When you consider that banks have donated over $221 million to politicians since 1990, it becomes very difficult to find a member of Congress who hasn’t been on the receiving end of this largesse. So Congress is just as, if not more inclined as the White House to insure the banks get taken care of.


All of the political drama is just that, drama. The banks will be helped out no matter what. The impact of the US losing its AAA credit rating is too enormous for the politicians to let it happen right now.


However, when it does happen… and it won’t be too long from now… the impact will make 2008 look like a picnic.


On that note, if you’ve yet to prepare your portfolio for Round Two of the Financial Crisis, you can find actionable investment ideas that will not only protect your portfolio, but help you produce outsized profits in my FREE report, The Financial Crisis “Round Two” Survival Kit.


This report is over 17 pages long and includes detailed analysis of why the First Round of the Financial Crisis happened, why the next round (Round Two) will be even worse than 2008, and which investments can produce triple digit winners when the market crumbles.


This report is 100% FREE. To pick up your copy today simply go to: http://www.gainspainscapital.com and click on the OUR FREE REPORTS tab.


Good Investing!


Graham Summers


PS. We also feature two other reports, one outlining how you can purchase Gold at just $350 per ounce and another featuring two investment ideas that will skyrocket as the world’s paper currencies collapse in an Inflationary Armageddon.


These other two reports How to Buy Gold at $350 and The Inflationary Armageddon are also available at the OUR FREE REPORTS tab on http://www.gainspainscapital.com.





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tony bonn's picture

there is not  a scenario in the world where any usa ratings agency would lower their ratings of usa debt from aaa.....such an action would bring on instant murder by the usa army delta force assassination squad, nationalization of fasb, and laws to declare usa debt aaa.....

it just isn't going to happen....

Obvious Paradox's picture

The AAA rating will not be down graded. Obummer has told the ratings agencies if they even think about it they will experience "Change you can believe in".

hannah's picture

+1000 no way they will downgrade when we push trillions of dollars towards the banking system which they are a part of......if they did downgrade, then congress would just pass a law that AAA is now AA then A the whatever....just like europe did.

Bear's picture

Why would the rating agencies ever think of lowering the AAA rating ... these are the same guys that govern DC and WS ... the only reason that is was ever brought up was to scare the sheeple

RiverRoad's picture

kaiserhoff @11;25:   Free markets rule and will do what TPTB don't have the "thimbles" to do.    +1

zeroman's picture



boredbutdeadly is right..non issue

ZeroAffect's picture

The affect of higher interest rates on the banks and the economy........KABOOM

BeerGoggles's picture

the stock Graham summers had subscribers buy a few weeks ago just fell 25%.



boredbutdeadly's picture

The risk based capital guidelines do not concern themselves with ratings.  US Treasuries are explicitly assigned the lowest risk rate, and this will not change, no matter what the rating agencies do (do you really expect the fed to push for a regulatory change on this?).

Of course, other financial players, such as insurance companies and pension funds, might have a problem.  However, I fully expect them to simply change their investment policy to allow them to continue doing what they are doing.

Looks like a tempest in a teapot.


onlooker's picture

What are the Vegas odds on this bet? Why would the most powerful government and the other governments like China, and the Worlds most powerful wealthy let this happen? I dont think so.

think about it

cranky-old-geezer's picture

Articles like this clearly displaying author doesn't know what the FUCK he's talking about detract from ZH's credibility.

US Treasury debt will keep AAA rating and not be defaulted on. If necessary POTUS will take 14th amendment authority on executive order and borrow enough to pay interest and maturing debt, irrespective of the debt ceiling, which isn't constitutionally mandated.

Constitution trumps acts of congress when push comes to shove. POTUS has constitutional authority to borrow enough money to pay federal government debt without approval of congress.

This has to be what Obame told UST bondholders, while telling the public default was imminent.

Actually he's right on both counts. Default on Treasury debt wouldn't happen, but default on current appropriations and expenditures would happen if congress didn't raise the debt ceiling. Bondholders would be paid but wages, salaries, entitlements, welfare, light bills, water bills, rent, invoices, and other current expenses wouldn't be paid. Treasury debt would be paid but current government operations would shut down.

That's the little truth POTUS doesn't want people to know about. Bondholders getting paid while government employees, contractors, vendors, entitlement recipients, welfare recipients, don't get paid would create a firestorm of protest that would cost Obame any chance of being reelected.

American sheeple think the president can do anything he wants. They wouldn't understand why Obame's "stash" ran out, and confidence in him would collapse.

dxj's picture

Ironic that the person calling another clueless is quick to talk about things he himself is clueless about - i.e. the Constitution.

Clowns on Acid's picture

Okay so USTs lose their AAA rating...would seem that all financial text books will have tro change theuir definition of the "risk free" rate from USTs to the rate of MSFT bonds ?

Maybe even the gold lending/ borrowing rate = risk free rate.

What will constitute "risk free" rate for all the futures and options formulas? Lotsa software / code changes in the electronic trading systems.


falak pema's picture

let berlusconi bunga bunga the Italian economy and the banks are toast...

LookingWithAmazement's picture

"What Happens When the US Banks Take a Hit On Their Senior-most Assets?"

The rules will simply be changed. Greek eurobonds being junk now, may still serve as collateral at the ECB; before the crisis this was supposed to be impossible and unthinkable. Same will happen in the US. Ratings lowered to junk? No big deal, just keep your junkbonds, because otherwise ... you know, armageddon and so. The collateral rules are smoke and mirrors, just rituals.

LawsofPhysics's picture

Graham,  where is Wells Fargo relative to these big boys?

Sudden Debt's picture

Banks will survive a downgrade. At least if rates rise accordingly. Let's say to 5 or 6% on a 10yr for example.


hardcleareye's picture

They cannot allow rates to rise without losing complete control of montary policy (some would argue that has already occured).  However, if rates rise they will have to remove liquidity or things go real bad

"The disturbing fact about this, however, is that inflation dynamics can potentially become unstable when a massive stock of base money is being kept in check by very low interest rates. This is because small increases in interest rates from near-zero levels imply huge changes in liquidity preference and velocity. If those changes are not offset by opposite and proportional changes in the monetary base, strong inflation pressures are likely to follow." http://www.hussmanfunds.com/wmc/wmc110124.htm

Add to that the article Tyler wrote a while ago about the Feds taking on interest default swaps..  if interest rates rise this thing implodes......  of course there are a shit load of others things that can also cause this to implode...

kaiserhoff's picture

Higher rates will torch their balance sheets, again, but it has to happen.

The biggest problem is that our dictators, er, leaders, on both sides of the pond, hate and fear free markets.