A commenter to one of my recent posts, pointed out, with approval, that support for a multi-trillion dollar debt ceiling extension has been voiced by both Ben Bernanke, Chairman of the Federal Reserve and Jamie Dimon, Chairman and CEO of JP Morgan Chase. The commenter viewed their support as being definitive, and I do not. However, I do support an extension of the debt ceiling. It is just that I am suspicious of the motives of either luminary — Bernanke or Dimon.
After all, Bernanke is the architect of Federal Reserve much-maligned quantitative easing I and II. He has presided over an enormous expansion of the Fed’s balance sheet, which holds over $1.6 trillion in Treasury securities (see here). Bernanke has been all over the map on what is happening with the economy, and has undertaken highly questionable Fed activities, so my confidence in his objectivity or competence has been shaken-- to say the least. And, I say that as someone who supported the choice of Bernanke to head the Fed.
Would big banks bite the hand that feeds them?
Dimon heads one of Wall Street’s biggest banks, which was the beneficiary of billions in Federal largesse during and after the financial panic. Dimon’s organization has prospered at least in part due to government connections, and he would be unlikely to go against the hand that feeds him. Of course, JP Morgan Chase owns lots of Treasury securities and a default would have a deleterious effect on its balance sheet and that of the other big banks such as Goldman Sachs, Bank of America, Citigroup and Morgan Stanley.
As you can see from this table, the big five Wall Street banks all hold substantial assets in Treasuries when compared to the actual equity of each bank.
Source: Motley Fool
Interestingly enough, Dimon’s position on this issue is still fairly nuanced in that he does not view a rating downgrade of U.S. Treasuries with too much angst. He does correctly fear an actual default or nonpayment of principal or interest, and I do too. Here are Dimon’s comments from a post on the Wall Street Journal’s Deal Journal blog [emphasis added]:
…Well, you know, when you say manage the risk around that, that’s a tough one to answer. The risk around — were you talking about just a downgrade risk? I think that’s manageable, but that will cause problems and issues because some people need AAA collateral, some people can’t own, so it will cause issues.
I don’t like the downgrade issue. But a government default issue is far more severe than that. And that would cut across (inaudible) lines, revolvers, takedown of revolvers, money market funds, securities lending, something like $3 trillion or $4 trillion of treasuries and uses collateral around the world. It would change the pricing of securities; some owners will be forced to sell because they’re not allowed to own default securities…
I thought it was interesting that he mentioned the downgrade of Treasury debt ratings as being manageable. Given the rate of increase in our debt each year, a downgrade may be inevitable. However, he correctly pointed out that default would be very bad. I agree.
As I pointed out in my post two days ago (The U.S. Treasury will not default ), the U.S. Treasury will not default on payment of principal and interest on the debt. Payments of principal and interest are mandated by the Constitution and fundable from revenues of nearly $200 billion per month.
Now, before you jump to any conclusions that I’m a knuckle-dragging troglodyte, anti-progress moron, consider this. I am simply pointing out that the Treasury cannot default on Treasury debt. That is simply a fact.
Raise the debt ceiling
I think the debt ceiling should be raised and I believe it will be raised. If it is not raised, we will be unable to meet many obligations and that will be very difficult. Nonetheless, the track we are on to have $1 trillion deficits as far as the eye can see is clearly unsustainable.
I have written before that I believe the Fed and Treasury are building up bank balance sheets on the backs of savers. Very low money market rates allow banks to pay little for assets that they then invest in Treasury securities at much higher rates. Nice work if you can get it. In other words, I believe this entire fiasco has harmed Americans, with those in the middle being the hardest hit.