Breakout

U.S. Debt Downgrade Is a Done Deal: Macke

Jeff Macke
Breakout

It's getting deeply weird in the world of finance. Price dislocations, big moves up or down on every official utterance from Washington, and markets attempting to price in the idea that maybe the folks in Washington are going to rip off our financial nose to spite our face.

What's it all mean and how should you play it? I have no idea, but at least I'm man enough to admit it. To help me at least form a best guess on outcomes and tell us what's happening in real-time, Breakout invited the Daily Ticker's Aaron Task on set for a special Yahoo! Finance Summit.

Aaron shared some insights on what institutions are doing to brace themselves. "Credit default wwap prices are rising on debt," notes Task. This means the markets are doing their own downgrading of U.S. debt. Forget Moody's and S&P, Mr. Market sets the price and right now he's saying there's increased risk in owning our debt securities. This is presumably what would happen in the event of a downgrade anyway, suggesting the ratings agencies are behind the curve yet again.

More evidence of the growing risk has come from our friends in Chicago. The CME announced they were raising what's called the "haircut" to U.S. debt posted as collateral. In English, the CME is treating U.S. debt the way life insurance companies treat people with heart problems; they'll still insure you but you have to pay more. Keep in mind an extreme version of raising margins on assets is how the CME burst the silver bubble in May. Levered up holders of U.S. debt need to put up more cash. If the holders can't pony up the dough they have to sell the debt. Forced selling has never led to higher prices in the history of anything financial.

There's a laundry list of other signals that investors are adjusting to in a new era in which U.S. debt has risk. In many ways this is recognition of the obvious but unpleasant truth. The end of denial, if you will. It could be argued, and Task does argue, that a little panic would be a good thing. The convulsions of the tape in response to the unarguably terrible GDP report "is not a bullish sign but helps people feel like "ok, now the politicians in Washington are going to realize (they) better do something here."

From Aaron's mouth to Washington's ears because right now market participants are attempting to fly blind and are getting a little twitchy about it. Markets hate uncertainty. Markets also hate government changing the trading rules in mid-game. Right now the government is intruding in the markets in an uncertain way. The only logical response for institutions is to take off as much risk as possible. That's more or less exactly what happened in 2008 when a bunch of crazy TARP stuff started happening.

We're not in 2008, but the lessons from those dark days hold true: It's time to appraise your portfolio from top to bottom and ask yourself "what would I do if I woke up and the Dow had moved 1,000 points higher or lower overnight?"

It's much better to have an answer for that question now rather than waiting for the market to force you to make up your mind later.

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