Default Scenarios

What are the scenarios that you have been thinking about with the US Government Default situation?

NBC News has seven.

1.  Depression and Unemployment

2.  Dollar down, prices and rates up

3.  Down go investments

4.  Social security payments halt

5.  Banking operations freeze

6.  Money market funds break

7.  Global markets walloped

If you are a risk manager, you have probably already worked through your nightmare scenario and have at least some ide of what you might do.

But if you are like the rest of us, you are probably just betting the they will work it out in the end.

Deep in our hearts, we would all choose a scenario with no surprises.  Peter Wack, the father of scenario planning at Shell

My personal scenario is a muddle through.  Just like in the situation of the Lehman default, where the decision was not to act until they saw the repercussions of the default ripple through global financial markets, the US Congress fails to reach a deal until some payments are delayed.  The Treasury goes forward with the deferral process – paying bills in order of when they were due once they have the money.  This goes on for a week or two and several of the NBC scenarios start to happen all at once.  Then Congress finally acts and extends the debt ceiling.

They are still all wrapped up in their own world though and they only pass an extension that will work for several months.  This turns out to be not enough to calm the markets and the chaos continues, even though the US is now paying its bills.

Ultimately, it results in the development of an alternate structure for the global reserve currency.  This results in a permanent rise in the cost of funds for the US government.  Which is itself catastrophic given the historically high debt levels and the long term government funding crisis.

But wait, discounting to the rescue.  With interest rates higher, the future value of many long term obligations, especially at the state and local level suddenly shifts downwards.  The funds that did the least to immunize themselves to interest rate shifts are saved by the power of compound interest as pension obligations magically shrink.

In the end, we – that is the developed countries that depend upon the modern financial system for our wealth – are all poorer by a third or more.  And the US eventually votes one party or the other into a majority position and we try one of their solutions for a time.

But that drop in wealth is only recovered over a generation.

Explore posts in the same categories: Financial Crisis


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One Comment on “Default Scenarios”

  1. […] Commentary on Risk and ERM « Default Scenarios […]

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