The Cost Of A US Downgrade: $100 Billion Per Year, Offsetting All Deficit "Reduction" Efforts

Tyler Durden's picture

Earlier today, while discussing the implications of a US debt downgrade on a SIFMA call, JPM head of fixed-income Terry Belton told listeners that a US downgrade could cost the US an additional 60-70 bps in incremental interest. That's per year. He also added that US asset managers are unlikely to sell Treasurys on a downgrade, but that's irrelevant. Nobody can predict what all the knock off events from a US downgrade would be, as the Citi presentation from yesterday indicated. Should there be a downgrade, investors may not sell Treasurys, but they sure will be forced to sell other lower rated instruments to keep the overall rating distribution of their portfolio in line with mandated rating requirements. Which in turn, following margin calls, will result in, you guessed it, selling of Treasurys. Yet this debate is the topic of another post. What is more important is that on the same call, Belton said that a 70 bps increase in interest would result in an incremental $100 billion in interest expense each year. As a reminder, this is roughly the amount that the NPV of a realistic deficit reduction plan over 10 years would chop off from the US deficit on a yearly basis. Simply said: the US downgrade alone, now virtually taken for granted by everyone, will offset any beneficial impact from any deficit reduction that will have to happen for the debt ceiling to be increased. And that, ladies and gentlemen, is why cash flows matters.

More from Reuters:

"That's on the order of $100 billion over time that we will add to our funding costs," said Terry Belton, global head of fixed income strategy at JPMorgan Chase. He was speaking on a conference call organized by the Securities Industry and Financial Markets Association, also known as SIFMA.


Over time, he said Treasury yields could rise 60 to 70 basis points on a credit downgrade -- "a huge number because we're talking a permanent increase in borrowing costs."


That would make it more costly for consumers and business to borrow money and could land the economy back in recession.


A default on the country's obligations would be even more disruptive, call participants said, and could ripple across financial markets, but was less likely.


In the short term, a downgrade would have a more subdued impact on markets, Belton said, with bond yields likely to rise five or 10 basis points.


Markets had feared a move to AA would spark forced selling, but Belton said "most investors have indicated they would be able to continue to hold them."


The "wild card" remains foreign demand over the longer run, sine the U.S. depends heavily on overseas investors -- mostly central banks -- to finance its deficit.


Belton said he expected demand for the $99 billion worth of fresh two-, five- and seven-year Treasury debt this week to be "on the weak side" and warned of even more concern if a debt ceiling impasse forces Treasury to postpone future auctions.


He said an eight-day auction delay surrounding a debt ceiling debate in 1995 cost the government 25 extra basis points in financing costs.

As yes, but back in 1995 the global economy was not run by a global central planning committee whose only purposes was to intertwine everyone in perpetuating the global debt-funded ponzi. This time nothing can possibly go wrong... or at least until such time as the house of cards propped up by Bernanke et al becomes so big that it finally collapses (the Fed can push the laws of finance and physics, but not break them) that the only rescue is for the Alpha Centuri central bank to come and bail out the world.

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Gubbmint Cheese's picture

with all due respect - I disagree. The loss of an A in debt rating is going to be a non-event.

Does anyone remember 2002?

How's that 10 year Japanese bond looking today? 1.10%?


Al Huxley's picture

I agree, it will be a non-event. CNN has a 'countdown to default' clock now - anything that's being hyped that much in the MSM is being used as misdirection and cover for something else. That's the one thing you can rely on from the 'news'.

SheepDog-One's picture

Well to be fair, CNN and the other 24/7 news cycle media run 'countdown clocks' on everything including release times for starlets to get out of rehab. 

Al Huxley's picture

touché :) However, those are also misdirections - bread and circuses to keep the viewing public occupied on trivialities so they don't notice what's actually happening around them.

Conrad Murray's picture

anything that's being hyped that much in the MSM is being used as misdirection and cover for something else


Two examples:

1. UN Agenda 21 and Executive Order 13575
2. Odumbo's attempt to subvert the 2nd Amendment by giving the UN control of arms through the Arms Trade Treaty(which even Democrats are coming out against)

SheepDog-One's picture

Well what about all the munis that cant by law be in anything not AAA? What does everyone do, just re-write the laws and invest in whatever? Hobo economics.

Al Huxley's picture

Yes,I expect that's exactly what they'll do. Its been done before with MBS, Greek debt, etc. - whatever it takes to keep the ponzi scheme alive another day.

chunkylover42's picture

I am not certain it will be a non-event.  The real damage potential lies in margin accounts, short-term funding and swaps markets.  Treasuries are used as collateral because they receive the smallest haircut, but that changes if the U.S. goes to AA.  Just yesterday CME announced they are increasing the haircut when U.S. Treasuries are posted as collateral.  This means that anyone at the edges of a levered position either has to post more collateral or sell assets to meet the requirements. 

Further, government money market funds and repo markets are often predicated on AAA-rated securities being used in the transaction (by contract or by prospectus).  This action could lead to a freezing of short-term funding markets, the same problem we had after Lehman. 

Plus you've got he knock-on effect of downgrading Agencies as well, which are also used throughout the markets.  Life insurance companies own a ton of long government paper because it's AAA-rated.  It's not clear-cut to me that this is a non-event, I think it's more likely the elephant in the room.

pazmaker's picture

I think the fat lady is starting to sing!   Get ready!!!

Bear's picture

This is insnaity ... The downgrade should come if the ceiling is raised and not the other way around. But I guess that its based upon the Banksters viewpoint

SheepDog-One's picture

Right, we're up against the debt and in danger of not making payments due to bankruptcy, so further debt printing and we're OK and our debt is more sound. Total bunch of nonsense.

Joe Davola's picture

Krugman sticks his fingers in his ears and shouts "La-la-la-la, I can't hear a word you're saying La-la-la-la"

mayhem_korner's picture

Agreed.  It's bizarro world and the legion of doom all wrapped in one.  The dollar should be strengthening and commodities softening at the prospect of a slow-down in debt/fiat printing.  But everything is working in reverse.  Which just goes to show how catastrophic the collapse will be.

Ghordius's picture

One year longer! Not happening...

CrashisOptimistic's picture

To say nothing at all about what $120 oil will take off the economy/gdp/tax revenues.

baby_BLYTHE's picture

and Ben can offset the offset by more pump priming

Mike2756's picture

So the 100B a year would be the increase in oil prices, not an interest rate rise.

SheepDog-One's picture

$100 billion, when we're in the hole $1.5 trillion every year. Or more. This is all just a damn joke. A SpongeBob bandaid on a severed limb. 

I wish theyd just ram it thru, then we can see how short lived it is and also see all the cuts to SS, Medicare, home mortgage deduction, theyve slipped thru.

Cognitive Dissonance's picture

Simply said: the US downgrade alone, now virtually taken for granted by everyone, will offset any beneficial impact from any deficit reduction that will have to happen for the debt ceiling to be increased. And that, ladies and gentlemen, is why cash flows matters.

That's just crazy talk Tyler. The almighty dollar can never be sullied unless you are a terrorist.


A born again dollar lover.

I love my Ally Bank dollar.

Ghordius's picture

How is your monetary Rapture going to look like

r101958's picture

If they are only trying to reduce the deficit by $100 billion then I would say we have a huge disconnect here. They should reduce spending by 20% this year alone.....and that would be about $720 billion (I know, not going to happen). That would still have us spending about $700 billion more than we take in. Moreover, it doesn't even touch the $14 trillion debt. Yes, I know it would cause a lot of pain but there is no other way really.

digitlman's picture

Wow.   Smells like we are winning the future!

Conrad Murray's picture

Bernanke, Obamao, Geithner, Dimon, Blankfein, Raines, Dodd, Frank...they all laugh in the faces of you slaves. Debt reduction doesn't matter. Downgrades don't matter. End the Fed. End the State.

Shell Game's picture

ah, heck.  Just Roll that Debt!


sing with me, Rollin', rollin', rollin'....keep that Debt a rollin', En--slaved!!

SheepDog-One's picture

Id rather sing 'I roll 2 joints before I roll 2 joints, and then I roll 2 more'

Shell Game's picture

Just don't bogart that fattie, Sheepdog.  ;)



Sudden Debt's picture

That's only 1000$ per working American. And we all know Americans make 1000$ on average a day right?


max2205's picture

Cut of 2nd House interest and cut of primary house interest will go down as the worst ever thing to do... a BIG BAG OF SUCK

SheepDog-One's picture

This will be a non event in the sense that when it happens, its already been baked in so many times over it will be immediately devoured and we'll just move to another emergency countdown clock. Politics of constant fear and terror.

Sudden Debt's picture

market will actually go down because the calculated already another 14 trillion in it.


SheepDog-One's picture

I dont see this impressing anyone either, this certainly isnt another 'Christmas in July' for Wall St at all. A few measely billion here and there?

JR's picture

When discussing the cost of a downgrade, how about one, just one, brave soul to tell us the cost to America for having “spectators” like JPM who “see what we need” while using the entire United States of America as their personal bail out backup.  Because of them we’ve been downgraded to the point of oblivion, and they’re worried about a downgrade if they don’t get their additional fix.  Here’s an opinion (edited down) from Richard Parker, a journalist and former associate publisher of the New Republic

Richard Parker: Tea party missed Wall Street memo | 7/26/2011

The debt ceiling debacle that is unfolding in Washington is not about ideology and it's not even about putting the nation's fiscal house in order. It's not even really about the American people. This is about appeasing just one group of people: the people on Wall Street. And before this is over, watch out for a Wall Street panic, which ultimately breaks the deadlock.

So far, the Street, frankly, has been largely asleep at the switch. Even as the economy has continued to falter it's been more than happy to keep the gears of commerce greased with plenty of government money.

And so the Street has thought: Hey, those guys down in Washington will make a deal, eventually. And a deal means predictability; and that's what investors, correctly, want. They want to know which corporate loopholes are opened or closed. And yes, they want to know if those Bush era tax cuts are going to be there when that big year-end bonus comes in. And like any bunch of bankers, the Street's got nothing against a bigger national debt — as long as there's a nice fat schedule to pay it down.

And both parties have been vying for the Street's favor. The Republicans on the tax side and the Democrats, now, on the spending side. And here's why: If President Obama can force a deal on his terms that Wall Street is OK with, the stock market could go through the roof, people could get jobs — and he's going to get a second term. If the congressional Republicans can get the Street what it wants then they can curry favor with people who have been traditionally Democratic donors, and capture Congress. And nobody in this equation could care less about the Republicans running for president.

But the Republicans have got one big problem: the tea party. The tea party's freshmen Republicans have held the line and insisted on cutting spending, even if that means not raising the debt ceiling above the current $14.3 trillion, even if it means defaulting on the debt. They've aligned themselves, too, with keeping the Bush-era tax cuts…it’s likely going to get ugly. The tea party isn't getting the message: Washington works for Wall Street…  

"Wall Street always wins, but they've been up against something more powerful: the tea party," says Jeff Connaughton, a former Senate chief of staff and now an ardent critic of Wall Street. "Why Wall Street hasn't yet understood that there's going to be a wreck is beyond me. The House is a stormy ocean. And we have no idea if the ship's going to make it to port or not."

Greenhead's picture

Isn't it a little amazing that when certain members of Congress actually listen to the voters who elected them to office, "it is a problem".  Those voters don't want more debt, are not on the government dole and don't want to pay more in taxes.  They want to be left alone and not be harassed nor fleeced.  What a concept!  It used to be called freedom.

JR's picture

Wow! Great summary!

Cdad's picture

Yep...yep...and for two days now, the infinite wisdom emminating from the criminal syndicate known as Wall Street is that of preparing expectations that the first ever downgrade of US debt is no big deal.

I'm starting to wonder if the current criminal crop on Wall Street is actually from Alpha Centuri.

SheepDog-One's picture

Right, up till now thats been 'unthinkable', now downgrade/default is 'no big deal really at all'.

impending doom's picture

No offense, but has there ever been a topic that you haven't commented on? The sheep could probably use some attention, dog...

Cole Younger's picture

And the hits just keep on coming...You have to hand it to these politicians....even when they think they are saving a buck, it cost them a buck. stupidity knows no bounds.....LOL...OH... Hmmmm......was this the plan all along to funnel the general fund to???? We could get a new conspiracy theory out of this one...give it will develope..

Seer's picture

“Today we are at a crossroads. One road leads to hopelessness and despair; the other, to total extinction. Let us pray we choose wisely.” – Woody Allen

It's intractable because continued growth on a finite planet isn't tractable/possible!

Raynja's picture

“Still, if you will not fight for the right when you can easily win without bloodshed, if you will not fight when your victory will be sure and not so costly, you may come to the moment when you will have to fight with all the odds against you and only a precarious chance for survival. There may be a worse case. You may have to fight when there is no chance of victory, because it is better to perish than to live as slaves.” –Winston Churchill

SheepDog-One's picture

A removal of an 'A' could result in 60 bps, of course causing wild chaos. Basically 'damned if we do, damned if we dont'...however theres some magical spot right in the middle thats somehow not bad at all. Or, we could just admit we're bankrupt, sever foreign entanglements, and get to rebuilding. Of course that does not shower banksters with billion of free dolars, so 0% chance of that.

oogs66's picture

first the 100 billion compounds, and in 10 years when the debt is doubled, it is 200 billion per year anyways.

Everybodys All American's picture

Should this not be noted as a Trillion dollar downgrade in keeping with Washington budget speak.

TradingChief's picture

Assuming there is such an offset, then one must also consider the down pressure on the US dollar, and what that will do for exports. So net-net it should result in more money for the FED not less.

TradingChief's picture

Assuming there is such an offset, then one must also consider the down pressure on the US dollar, and what that will do for exports. So net-net it should result in more money for the FED not less.

johny2's picture

deleted, it was my other personality that wrote earlier comment

wombats's picture

Who loses from a Default?  JPM, GS, other TBTF banks lose, but the country as a whole will be better off with a revision to mean.  If we go back to honest money (gold) the budgetary discipline imposed will go a long way to solving our problems with runaway wasteful spending.  Our wars would probably quickly end and our inflation problems would likely evaporate just as they did after the revolution when the constitution first instituted the gold standard.

Whatever subsequent borrowing might be needed would be backed by honest money so risk rates seem likely to be relatively low too.

Sure the transition to a reset and reintroduction of a gold standard would be disruptive and painful, but in the end we will all be better off.

Dr. Engali's picture

The banks won't lose. They will restructure some of the loans and give up a little to make it look like they care about the general welfare of the country. But in actuallity what will happen is they will lengthen the term of the loans at an affordable rate and collect interest over a longer time frame. The banks never want to recieve their money back. With them it's all about the cash flow so the can make more bigger and better loans.

Mesquite's picture

> wombats.. Ok

But with all the entrenched power of tptb (over centuries..) do we really stand a chance of this EVER happenning now, along with the conditioned masses' expectations thrown in..??