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This catastrophe will happen if there’s a default: Bove

Talking Numbers

If politicians don’t get their act together quickly, America could be facing a depression. So warns Dick Bove, vice president of Rafferty Capital and one of the most followed banking analysts around.

In the nearly half century Dick Bove has worked on Wall Street, he’s seen it all: bubbles, crashes, and global calamities. But, he has never seen anything as crazy – or potentially harmful – as what’s happening right now in Washington.

That’s because if politicians don’t get their act together quickly, America could be facing a depression. So warns Bove, vice president of Rafferty Capital and one of the most followed banking analysts around.

As the federal government shutdown continues on through its eighth day, another deadline looms – October 17, when according to US Treasury Secretary Jack Lew, the US debt limit will be reached.

Many on Wall Street agree with Bove that the consequences of a default would be so disastrous that the political leadership will somehow figure a way out of this mess. For example, Pimco’s co-founder Bill Gross recently put the odds of such an event occurring at one in a billion. Gross would have much to lose in a default; the Pimco Total Return Fund has about 35% of its $251 billion assets in what it refers to as “US government-related” debt.

Overall, mutual funds like Pimco own close to $1 trillion of US Treasury securities and would suffer greatly in a default. And mutual funds aren’t even the biggest holders of US debt.

(Read: Traders brace for more DC-induced volatility)

Data from the US Treasury Department show how ownership of the federal government’s more than $16.7 trillion in debt breaks down.

Entity owning US debt Value of US Treasury securities ($ billions) Percentage of total
Federal Reserve and government accounts $6,657 40%
Foreign & international 5,724 34%
Mutual funds 946 6%
State & local governments 475 3%
Private pension funds 458 3%
Depository institutions (banks, etc.) 341 2%
Insurance companies 263 2%
State & local government pension funds 229 1%
US savings bonds 182 1%
Other 1,497 9%
Total as of March 2013 $16,772

The Fed has been buying US Treasury and mortgage bonds for several years now in an effort to stimulate the economy. As of December 2012, it’s been purchasing at a rate of $85 billion per month. Also in the bucket labeled “Federal Reserve and government accounts” are bonds held by Social Security.

The value of foreign ownership of US debt has diminished somewhat since the bond selloff that began in the spring. From March 2013 to July 2013, the value of foreign ownership of US debt went from $5.7 trillion to just under $5.6 trillion. Still, some five entities own more than half of all foreign governments share of US debt.

Entity owning US debt Value of US Treasury securities ($ billions) Percentage of foreign total Percentage of total US debt
China $1,277.3 22.8% 7.6%
Japan 1,135.4 20.3% 6.8%
Caribbean banking centers 287.7 5.1% 1.7%
OPEC nations 257.7 4.6% 1.5%
Brazil 256.4 4.6% 1.5%
All others 2,375.5 42.5% 14%
Total as of July 2013 $5,590.0 33.4%

“Caribbean banking centers” as defined by the US Treasury Department include the Cayman Islands, the Bahamas, and Bermuda, among others. The Treasury also categorizes OPEC nations as “Oil Exporters” and includes Venezuela and Iran, two countries on not-so-friendly terms with the United States.

(Read: http://www.cnbc.com/id/101076616)

Dick Bove doesn’t believe the US government will default on its bonds. But, if they do, he thinks the effect would be devastating to the US economy.

“It would be almost insane for the United States government to stimulate a default,” warns Bove. “In my view, a default is equal to a depression.”

“If they default, since roughly 25% of the debt of the United States is owned by the Social Security fund, you would be taking income away from seniors,” says Bove. ”Based on the amount of assets the Federal Reserve owns in terms of Treasury debt, it’s about 51 times their equity, so you’d bankrupt the Federal Reserve in theory.”

The other entities would likely dump sizeable portions of their debt, according to Bove. That would drop bond prices, raise bond yields, and make it virtually impossible for corporations to borrow money. And it could wipe out a large chunk of the equity of American banks.

Though Bove believes the government won’t default, he lays out the nightmare scenario of what could happen to the United States financial system in the event of a default. Watch the video above to hear more of what Bove has to say about what’s at stake.

More on Talking Numbers:

Dick Bove loves this bank
Surprise! Here’s why Apple may be a growth stock
Will earnings tank stocks?

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