Wall Street sign outside the New York Stock Exchange. (Press Association via AP Images)
When Senator Elizabeth Warren addressed members of the Financial Services Roundtable in Washington on Thursday, she began by recounting the first time she spoke to the trade group, representing the country’s largest banking and financial interests, in 2010.
At the time, the Dodd-Frank bill had just been passed after bruising battles with the industry, and she was in the process of setting up the Consumer Financial Protection Bureau, which the financial sector and its allies in Congress loathed and would repeatedly try to defang. “When [Chairman] Richard Davis introduced me, he said that in the interest of safety, all knives had been removed from the tables,” Warren recalled. “It was a joke—or at least I hope it was.”
Indeed, Warren is very familiar with Wall Street’s awesome power to influence the policy process in Washington. Which is why she came to them with a plea: please do more to avert a debt-ceiling breach and the potential calamity that would result.
You protect your interests every day in Washington. Ending this destructive notion of politics by hostage-taking is in your interests. And preventing an actual default—a self-inflicted wound that could cause a spike in interest rates and a freeze in our credit markets—is clearly in your interests.
I know that many of you have already spoken out, and I’m grateful for that. But please keep at it. For those of you who haven’t, please start now. Speak up publicly and write op-eds and give interviews. One conversation won’t get this done. Think of it this way: it took years of effort—press conferences and op-eds and town halls and hearings—for the debt-ceiling hardliners to raise this issue in the public consciousness, and now almost half of the country thinks that Congress should not raise the debt ceiling. It will take that kind of effort to reverse the tide.
What’s odd is that she had to say anything. One would think the financial sector would be applying a full-court press to stop a devastating fiscal meltdown that would wreak havoc on the Street (and most everywhere else). But implicit in Warren’s plea was that bankers haven’t been doing nearly enough.
Sure, some have spoken out, as she noted—like Goldman Sachs CEO Lloyd Blankfein at the Clinton Global Initiative yesterday. But the pleas have been soft, and virtually no pressure is actually being exerted in Washington. There’s nothing like the coordinated campaign that almost stopped the CFPB from actually having a director.
Why? The most obvious explanation is that Wall Street as a whole simply doesn’t believe the country will default. As always, the financial sector lets its money do the loudest talking, and the markets clearly are not anticipating a default. Goldman just released a report that found no discernible reaction in the S&P 500 to a potential debt-ceiling breach. “Complacency is even more pronounced on stocks with high government exposure,” wrote Goldman analysts. “Fear priced into options on these stocks dropped over the past few months to new lows.”
This all seems to be based in a belief that lawmakers will find their way to a deal—that the risks are so high, it is just a foregone conclusion. “DC always gets very close to the edge and then in the end finds an eleventh-hour solution,” Goldman’s chief economist told Politico last month. Another analyst told Business Insider this week that “I tend to think Wall Street has gotten numb to the antics out of a very partisan DC process.”
This attitude was more colorfully described by a trader in another Business Insider story: “I’m just here looking at my charts minding my own business you know what I’m saying? I don’t have time to worry about debt ceilings and the government. These people are a hot mess. I can’t…. You got a bunch of clowns reading each other Dr. Seuss. Why should I worry about what they’re doing, or not doing?”
Wall Street should care, however—a lot. As Ezra Klein noted earlier this week, the dynamics of this showdown are uniquely dangerous, much more so than what happened in 2011.
Then, at least both sides agreed there had to be a deal on the debt ceiling. Now, Obama is refusing to negotiate on it (much to his credit, of course—the country can’t keep playing chicken with calamity) and Republicans not only want to negotiate, but many members insist on pie-in-the-sky demands Obama cannot and will not honor even if he wanted to negotiate. That’s alongside the non-trivial number of members in the House who want to vote against raising the debt ceiling almost regardless of any deal, just to teach the country a “lesson” about debt.
If John Boehner can’t put together enough votes to make all these members with wildly disparate imperatives by October 17—at the latest—the country really might default. And the damage would be catastrophic.
The country did actually default briefly once before, by accident, due in part to a word-processing error. As Pema Levy wrote this week, that brief blip cost investors about $12 billion. A prolonged and purposeful default could create a real calamity in the financial markets. “I disagree incredibly strongly with the notion that breaching the debt ceiling would not have major, catastrophic consequences,” economist Mark Zandi told Levy.
Warren informed the Financial Services Roundtable’s guests, in case they didn’t already know, that it would be quite bad. “If the government’s borrowing costs go up, your costs will go up. And if consumer confidence drops, your customers will spend less. The debt ceiling isn’t a Washington problem; it is an American problem,” she said.
But it could be worse. Much worse—the sort of disaster on Wall Street that sees CNBC footage traders clutching their belongings in a box outside their firm, which just went belly-up with no warning. Then a domino effect of failed financial institutions and a global economic crisis.
Former Representative Brad Miller, a Democrat who served on the Financial Services Committee until retiring last year, persuasively sounded that alarm in Politico this week in a piece titled “How Congress Could Blow Up the Economy.”
He observed that Wall Street’s shadow banking system is particularly vulnerable to a default. It’s a system based on so-called “repo lending,” which is short-term lending outside the commercial banking system. Basically, a financial institution sells an asset to another institution with a contract to repurchase it the next day.
The lender keeps that asset as collateral, and as long as that collateral exists and is trusted by all the market players, everything might be fine. Which is good, because the Federal Reserve estimates $4.6 trillion changes hands in repurchase agreements every day, and it touches most all corners of the financial system.
But the most common form of collateral in these arrangements are US Treasury notes—and their value would naturally be called into question if the Treasury stops paying debts because of a default. Their value could be called into question even if that prospect suddenly appears real. Lenders would start asking for more collateral, on a scale that many institutions might not be able to meet.
Miller warns that a sudden flood of demands for more collateral is the stuff of massive institutional collapse—it could destroy this massive shadow banking system. A sudden demand for collateral is largely what created the 2008 financial crisis.
More recently, Miller notes, it’s what sunk the infamous MF Global, which bought a bunch of Italian sovereign debt through repurchase agreements, at low prices, and gambled the debt would be repaid in full eventually. The firm would make a killing in that case. But doubts were then raised about the stability of the Italian financial system, the firm’s shadow bank lenders demanded more collateral, and boom—the firm went under.
Miller charges that Congress simply doesn’t realize how real, and dangerous, this possibility is. “MF Global’s failure to anticipate demands for more collateral was perplexing, since they were thought to be smart and to have a sophisticated understanding of the financial system,” he wrote. “Does anyone think that about Congress?”
Few do. So here is a situation with the debt ceiling where members of Congress are blasé about risks to the financial sector and world economy, while meanwhile people in the financial sector are blasé about the very real chance Congress can’t reach a deal. And a economic calamity awaits.
That’s why Warren made her plea today—there isn’t much hope that the Ted Cruzes of the world will suddenly wise up. So Wall Street should probably stop fiddling.
John Nichols wonders if they House GOP forgot who won the election in 2012.