The Doomsday Scenario Has Happened

Here's What Banks Said They Would Do
Courtney Comstock | Aug. 6, 2011, 7:29 AM

Friday night the S&P downgraded the U.S. credit rating from AAA to AA+.


To bankers, a default, resulting in a downgrade, coupled with higher capital requirements is the "doomsday scenario" that banks said they were preparing for last month. This is totally different from a default, but banks were preparing for both.

Phillips, a political economist at Goldman Sachs, warned clients on a conference call last month that financial sector banks might have higher capital requirements if Treasuries are downgraded. "The complicated factor comes in with some of the larger firms, there could be a slight uptick in the calculated capital required to be set aside related to holdings. But a very minor change in capital requirements."

We wrote an article back then about what they were doing to prepare in the event of the doomsday scenario. Here it is:

The Wall Street Journal says that "according to one banking industry representative, there are indications banks are beginning to take steps to adjust their holdings of Treasuries to prepare for the possibility of default."

So it sounds like banks are preparing to dump Treasuries in the event of a default, because ratings agencies have indicated that they will downgrade the U.S. if there is a default. In fact, they've said that ratings agencies might downgrade the U.S. to AA within 90 days even if there isn't a default. If there's isn't a "credible" plan, S&P says it will downgrade the U.S. (long-term only) to AA.

But of course there's a good chance they won't. If the U.S. avoids a default, there would be no need. And even if the U.S. does get a downgrade, the WSJ says "it's unclear whether regulators would require banks to raise capital against Treasuries in the case of default. Most observers believe regulators wouldn't do this, but regulators haven't said."

Also because if they dump them, what's left to buy?

And people seem to be criticizing the ratings agencies for saying that they would downgrade the U.S., so perhaps they'll backtrack. Also on the Goldman conference call, Former Senator Judd Gregg said, "The ratings agencies put themselves in a corner that's foolish. I've always found them to be incredibly naive about the political process. To be so definitive is foolish."

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