The End of Capitalism Is Probably Not Nigh

Our recent Catalyst tweet about the current Obama Care – US default debate (If short term US Libor’s lower than Fed Funds (TED spread neg), in theory US govt default risk is greater than the banks) has set me thinking.

According to my Catalyst colleague and leading risk expert Christian Lee, in the 5 years leading up to 2007, life as a risk manager was relatively dull. But in recent years it’s been much more fun.

I guess it all depends how you see fun. I’m just a humble programmer making his way in the world.  But given the current Obama Care – US default debate, this is what strikes me:

· Gold hasn’t spiked – as one would expect it to. It’s trading at a 25% discount to 12 months ago and a 5% discount to 30 days ago.

· US Sovereign CDS spreads are on the up, but not significantly, and volumes are still low – they don’t seem to be pricing-in a default.

So I thought I’d ask Christian what I really wanted to know:

What does the current situation mean for US Treasuries being used as margin? Bigger haircuts?

Possibly, but it all depends not on the actual level but on the underlying volatility. They would be looking at revising concentration limits ie introduce greater diversity into the collateral pool.

As a risk expert, what would you be doing on October 17th if you were still working in-house and the US coupon payment was missed?

I’d already be running and analyzing all sorts of stress scenarios at the moment. Apart from CDSs (where such a situation may be a credit event), even with the coupon being missed this would not necessarily be a default event for clearing members. But we would have all US members and clients under the microscope – particularly agencies such as Fannie Mae / Freddie Mac. It would be interesting to be in the DTCC’s shoes though, where they are effectively guaranteeing a lot of US bond business.

What would banks do on that day – what would the immediate effects be?

As above – there’d be lots of analysis around impact on proprietary and client business. The concern would be about the knock-on impact with respect to interbank liquidity: this is what really kills banks.

If short-term liquidity dried up, who would save the banks if there wasn’t a Fed to open the discount window?

Well, it would be unprecedented and I can’t see that happening. But if it did it’s Armageddon: the end of capitalism as we know it.

OK – so dull suddenly looks a whole lot more attractive.  What do you think?