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

Contributions

University of California

$1,591,395

Goldman Sachs

$994,795

Harvard

$854,747

Microsoft

$833,617

CitiGroup

$701,290

JP Morgan

$695,132

 

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

48%

52%

 

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.

 

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Good Investing!

 

Graham Summers

 

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