Oct 08, 2013

    US default would dwarf Lehman crisis


    ANYONE who remembers the collapse of Lehman Brothers little more than five years ago knows what a global financial disaster is.

    A United States government default - just weeks away if Congress fails to raise the debt ceiling, as it now threatens to do - would be an economic calamity like none the world has ever seen.

    Failure by the world's largest borrower to pay its debt - unprecedented in modern history - would devastate stock markets from Brazil to Zurich, halt a US$5-trillion (S$6.2-trillion) lending mechanism for investors who rely on Treasuries, blow up borrowing costs for billions of people and companies, ravage the US dollar, and throw the US and world economies into a recession that probably would become a depression.

    Among the dozens of money managers, economists, bankers, traders and former government officials interviewed for this story, few view a US default as anything other than a financial apocalypse.

    The US$12 trillion of outstanding government debt is 23 times the US$517 billion Lehman owed when it filed for bankruptcy on Sept 15, 2008.

    "If it were to occur - and it's a big if - one would expect a series of legal triggers, potentially transmitting the default to many other markets," said Mr Mohamed El-Erian, chief executive of Pacific Investment Management.

    The US stock market lost almost half its value in the five months following Lehman's failure. The country had its worst recession since the Great Depression, taking the global economy down with it. Unemployment surged to 10 per cent.

    Another depression was prevented only by unprecedented action by the Federal Reserve, which pumped US$3 trillion into the financial system.

    "If we miss an interest payment, that would blow Lehman out of the water," said Mr Tim Bitsberger, a former Treasury official under president George W. Bush and now a managing director at BNP Paribas.

    One unexpected consequence of Lehman's collapse was the seizing up of the repurchase-agreement, or repo, market - a form of secured, short-term borrowing used by Wall Street banks and investment firms.

    Many of Lehman's trading counterparts discovered that the collateral they believed was backing their loans wasn't there to grab as rules allowed. That scared investors in the rest of the market, closing off other trades and leading to fire sales of securities and further price declines.

    A government default could freeze the repo market more than Lehman's collapse because US debt forms its backbone.

    While none of the people interviewed for this story expect the world's largest economy to default, most say the chances of it happening now are higher than in the past.

    "It would be insane to default, but it's no longer a zero per cent probability," said Mr Simon Johnson, a former chief economist of the International Monetary Fund, who teaches economics at the Massachusetts Institute of Technology.