Analysts Liken Potential U.S. Default to Lehman Brothers' Fall

The federal government shutdown has captured the attention of many analysts, especially with the approach of the Oct. 17 deadline to raise the debt ceiling and avoid a default on U.S. debt obligations. Given the potential global financial disaster that could follow such a default, some financial and capital market analysts are likening the situation to what occurred following the collapse of Lehman Brothers, which eventually resulted in one of the largest corporate bankruptcy law filings in history.

In the case of Lehman, the capital markets seized up due to traders’ concerns about the level of impacted collateralized debt obligations that their trading partners might be holding.  In the case of a U.S. debt ceiling breach, the vast part of the capital markets which is based on or depends on Treasury bills for fluidity would seize up as traders wondered when and if Treasury bill collateral would be paid off by the U.S.

In fact, today’s situation could be far worse than that of 2008. The $12 trillion of outstanding U.S. government debt is 23 times the $517 billion that Lehman owed when it sought bankruptcy protection, and the global repercussions could be much worse, Bloomberg reports. The likely damage includes driving up borrowing costs for billions of people and companies, undermining U.S. credibility, and plunging world economies into a recession or, potentially, a global depression. At the least, a U.S. debt default would shock the investment community and cause market instability, particularly with regard to the repurchase agreement market, which all but froze after Lehman collapsed. Still, although many of the ramifications of a U.S. default would have effects similar to those following the Lehman bankruptcy, former Treasury official Tim Bitsberger said that the two simply aren’t even in the same league.

“If we miss an interest payment [on U.S. debt obligations], that would blow Lehman out of the water,” said Bitsberger, according to Bloomberg. “Lehman was an isolated company, and now we are talking about the U.S. government.”

Foreign leaders have already voiced their concerns about a potential U.S. default, with China expressing the largest amount of worry. The Asian country currently holds 22.85 percent of U.S. debt held by foreign parties, making it America’s largest foreign creditor. [The vast majority of U.S. Treasury bills is still held by U.S. citizens and organizations.]

“We ask that the United States earnestly takes steps to resolve in a timely way before October 17 the political (issues) around the debt ceiling and prevent a U.S. debt default to ensure safety of Chinese investment in the United States and the global economic recovery,” said China’s vice finance minister Zhu Guangyao.

Given the effects that might flow from a Chinese loss of confidence in the U.S. capital markets, Capital Hill in Washington would be wise to pay heed.