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Wednesday, July 27, 2011

Stick it to the bond holders

I, like much of the public, have been watching this slow motion debt debacle unwind over the past few months. It is remarkable how no one, not even the routinely self-confident pundits, have any idea how this will play out. Will we default or will Tuesday pass without any immediate consequences absent a debt ceiling deal? I have heard more than one explanation which points out that technical default is extremely unlikely since the Federal tax receipts are more than enough to pay interest on Treasury securities. However, it occurred to me that payment depends on being both being able to pay and the desire to do so.

During the financial meltdown in 2009, GM went bankrupt. At that time, I had the misfortune to hold GM bonds. I knew the company was in financial troubles but we held the bonds and not the stock. Financial precedence held that bond holders would be first in line if GM went belly up. So much for this historical precedence. The bond holders were left holding the bag in a political deal which leapfrogged the UAW ahead their claims. 

Fast forward to 2011 and we have the US government in financial straits. There are multiple parties who have a claims on US government cash, including holders of treasury bonds. There is no question that markets have assumed up until the present that the holders of US government debt will be first in line to be paid if the debt ceiling is not raised. Rates on Treasuries are at historical lows and have remained so all during this crisis. However, let us say for argument's sake that the Treasury elects to place payment of interest on the debt as a lower priority than anything else.

Basically, default on our debt, even with failure to raise the debt ceiling is a choice which the Treasury can make. Everyone assumes that no one in their right mind would make such a choice if the money is available. Alternatives such as furloughs of federal workers, closing of non-essential federal agencies, delay of payments to doctors and hospitals could be done. However, might there not be a political game to play to the advantage of the President by intentionally inducing default? Default would reek havoc with the financial world,  but havoc creates opportunities, the most important being one to blame the Republicans for the chaos.

It is a high stakes game but the payoff is potentially huge. The nuances of understanding the real financial choices is beyond the understanding of most of the American public, likely independent of educational status. The public is likely to believe him if he claims he had to choice but stiff the bondholders. He has done this before and  suffered no consequences. That such an outcome may trigger a terrible financial calamity is most likely to result in pillorying of his opponents, despite the fact that the choice not to pay the bondholders lies with the Executive branch.

Yes...stick it to the bondholders again, create chaos, blame the Republicans, get re-elected with control of Congress.

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