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Christian Hviid
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An Investment strategist with multi-billion dollar portfolio management experience managing active Absolute and Relative oriented strategies in Unified Managed Account and Separate Account settings. Cross functional expertise covering asset allocation, risk management, manager and investment due... More
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  • Systemic Risk Rising as a Result of Possible Treasury Default/Downgrade 1 comment
    Jul 27, 2011 12:40 AM
    By now everyone probably understands what it means for the government to potentially default on its debt if the debt ceiling issue does not get resolved before August 2nd. It means that invoices to the government, interest and principal payments may be delayed. The effect on the economy will be broad and painful. There is a major unintended consequence that results out of allowing Treasuries to go into default. Recall, if something defaults by definition it is probably not worth par at that given time. This indeed could spell trouble for the global banking sector once again and cause another “run on the bank”. This time the origin of systemic risk, which Congress and the White House is recklessly gambling with, has to do with all Treasury collateral held across capital markets and for that matter globally. What if all that collateral’s par value is temporarily not worth 100-cents on the dollar?
    Well in today’s environment, the collateral is what may take a haircut! With almost $4 trillion in Treasuries used as repo collateral according to a recent JP Morgan study, the consequences could be dire. Haircuts on repo transactions could be increased which in turn could lead to margin calls and a negative feedback loop could ensue causing massive deleveraging and broad selling. The question also becomes whether or not money market instruments holding Treasuries would be required to mark holdings and depending on severity of any downgrade may not be able to hold them if ratings get cut sufficiently (anything below “A”). This could possibly signify money market funds “breaking the buck”.
    This systemic risk is unprecedented and highly unpredictable. The consequences are far reaching and could mean that the US status as a “safe haven” and the greenback being a global reserve currency may be put to the test. The damage to the US reputation would be long lasting. There are little places to hide in an event like this as we could experience another bout of deleveraging with trickle effects to the broader economy. Higher interest rates would almost be a certainty and risk premiums would sky rocket across asset classes. Let’s hope the barrel is empty when Congress and the White House pull the trigger playing Russian roulette with regards to the debt ceiling discussions. The US reputation, the global macro economy and capital markets are all at risk.
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  • Christian Hviid
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    Author’s reply » Some confirmation....

    27 Jul 2011, 04:06 PM Reply Like
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  • HY bonds pricing ca. 6.7% default rate. Par-weighted DR has been running 1.2%. This spells opportunity (I am long HYG as of this posting).
    Oct 21, 2011
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