Wall Street set to act on default, but how?

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As the U.S. neared a potential default or downgrade of its triple-A credit rating, many of the brightest financial minds on Wall Street were talking battle plans.

But few of them have taken significant action. The main reason: No one knows exactly what to do.

"If you don't know what you're going to do when the event happens, how do you make a trading decision?" said Alan De Rose, managing director of government trading and finance at Oppenheimer & Co. "That's a very difficult position."

Signs of confusion continued in early trading Monday. The dollar barely moved despite signs over the weekend that little progress was made toward resolving the budget standoff. The dollar changed hands at about 78.35 yen, down slightly from 78.55 yen late Friday. The euro was essentially flat against the dollar from Friday's close, trading around $1.4370.

U.S. stock-index futures declined in electronic trading. Futures on the Dow Jones Industrial Average and S&P 500 were down about 1%. Gold futures rose by about 1%.

Among the questions facing investors: After such a shock, would investors run away from Treasurys, which have long served as a safe haven? Or would they run to them, out of habit? Experts who have followed Treasurys for their entire careers make compelling arguments both ways.

"We're still figuring some of it out," says Mohamed El-Erian, chief executive and co-chief investment officer of Pacific Investment Management Co., manager of the world's largest bond fund. "And it's on the table as a risk."

On Sunday evening, Mr. El-Erian said in an email that the "political ground is being prepared for a short-term stop-gap compromise" that probably will push stocks and the dollar lower and leave the U.S. debt rating "extremely exposed to a damaging downgrade."

In one recent meeting at a major bank, executives were asked to suggest what they would recommend buying the very moment the debt limit wasn't raised. For each argument made, there was a valid counterargument for why the purchase wouldn't be wise.

Until very recently, the financial markets persistently shrugged off headlines on the debt ceiling as so much political theater. Bond yields fell as people rushed to Treasurys for safety amid the European debt crisis. Stocks pushed higher on relatively strong earnings.

Last week, as leaders in Washington continued to wrangle over ways to cut the deficit as the deadline to raise the debt ceiling approached, Treasury yields showed increasing sensitivity to the debate. The yield on the 30-year Treasury—most susceptible to long-term concerns about the U.S. fiscal position—was buffeted by headlines on potential debt-ceiling deals. Stocks wavered but ended the week close to their highest level since the financial crisis.

Some argued that markets could have a relatively benign reaction to a default, or a downgrade of U.S. debt. Investors have been wrestling for months with significant uncertainty and risks from the European debt crisis, the aftermath of the Japanese earthquake and the political upheaval in the Middle East.

Amid such caution, the impact of bad news on the budget deficit could be limited beyond a knee-jerk reaction, they argue.

On the margins, some have made moves. Some Treasurys trading desks have cut down on risk. Money-market mutual funds and hedge funds are holding more cash. Industry groups are starting to consider how to handle technical issues related to a possible default.

Hedge funds and other investors are already in defensive mode, relying less on leverage and hedging themselves against the risk of downward market moves.

That has been a drag on performance as stocks rallied in the first half of the year, but could cushion the blow of a selloff in stocks.

Individual investors have been steadily pulling money out of U.S. stocks funds for several months, withdrawing $20 billion in June alone, according to the Investment Company Institute.

Many advisers, too, have been playing it safe.

"We have been in a defensive posture for most of this year," and the budget debate hasn't changed that, said Michael Maloon, a financial adviser in San Ramon, Calif. Those defensive holdings include insured certificates of deposit and short-term bond funds. "The low yields are killing us, but we are primarily concerned with principal preservation."

Wall Street dealers, which buy and sell securities, are showing less willingness to hold riskier investments they have bought from customers.

"People are trying to keep their positions tight," said Alan Mittleman, head of global U.S. dollar rates trading at Société Générale . "With the debt-ceiling uncertainty, there's a lot of unwillingness to take risk right now."

The confusion has to do in part with the unique role of U.S. Treasury debt in the financial markets. Because of the size of the market, the ease of trading and pristine credit history of the U.S., Treasurys are used as the building blocks of capital for banks.

They are the place investors run to and hide when trading gets choppy, and they are the collateral of choice for the short-term lending markets that are at the heart of the world's financial plumbing system. They are also a widely popular investment for risk-averse money-market mutual funds.

Months ago, Fidelity Investments began drafting contingency plans and doing stress tests on its Treasury money-market funds for the various scenarios coming out of Washington, says Robert Brown, Fidelity's Money Market Group President. A couple of weeks ago, representatives from the firm began reaching out to clients and continue to keep a close eye on the news out of Washington, he says, while maintaining more liquidity than in the past.

Some investors are optimistic about the potential market outcomes despite the jostling. For many, the renewed conversations about risk management are reminiscent of 2008's wild ride.

"Anyone who lived through the fall of 2008 needs to understand that the financial system isn't as robust as we all hoped," says Jaret Seiberg, a policy analyst with MF Global's Washington Research Group. He pointed to concerns ranging from interest rates on mortgages to the impacts of a downgrade on the municipal-bond market to the use of Treasurys as collateral for swaps and derivatives.

"We still don't know what to do without triple-A U.S. debt," he said.

http://online.wsj.com/article/SB10001424053111904772304576466373207538638.html

[scandal 951]

The confusion has to do in part with the unique role of U.S. Treasury debt in the financial markets. Because of the size of the market, the ease of trading and pristine credit history of the U.S., Treasurys are used as the building blocks of capital for banks.

Yup. Exactly.

"Anyone who lived through the fall of 2008 needs to understand that the financial system isn't as robust as we all hoped," says Jaret Seiberg, a policy analyst with MF Global's Washington Research Group. He pointed to concerns ranging from interest rates on mortgages to the impacts of a downgrade on the municipal-bond market to the use of Treasurys as collateral for swaps and derivatives.

"We still don't know what to do without triple-A U.S. debt," he said.

Yup. Exactly.

[luckytxn 2,265]

Wahhhh Wahhhh Wahhhhh.

[Mr. Big Dog 10,747]

Wahhhh Wahhhh Wahhhhh.

That's what the Tea Party freaks will sound like when they have managed to throw the world into depression. No more government teat for these idiots.