Is U.S. Debt A Safe Haven For Its Own Downgrade?

Has U.S. government debt become a safe haven for its own downgrade? Some think so since mortgage (Fannie & Freddie) and Treasury bonds still look ok relative to other global options, but that theory has yet to play out.

One thing for sure is that US banks are holding on to more cash and locking in longer-term financing as they brace themselves for the consequences of a potential downgrade of the US’s triple A credit rating. The Financial Times notes that if US government bonds lose their AAA rating, banks using them as collateral may have to endure higher “haircuts” on the collateral, potentially sparking a credit crunch especially in the $3 trillion repurchase, or “repo”, market, on which large institutions rely for short-term funding.

Bank of America is not out of the woods yet. Recently six Federal Home Loan banks have “launched a salvo” against Bank of America’s proposed $8.5 billion mortgage bondholder settlement, suggesting the payout may need to be triple that amount. “Research reports used to determine the settlement figure were too favorable to B of A, used faulty estimates from the Charlotte, N.C., bank and ‘raise more questions than they answer.'” This reminds us that the FHLB’s don’t all have to act together in matters such as this, and the six (Boston, Chicago, Indianapolis, Pittsburgh, San Francisco and Seattle) have filed a separate claim. Others, such as the Federal Home Loan Bank of Atlanta were part of the June settlement along with PIMCO and BlackRock.

Flagstar is not out of the woods yet, either. The holding company for Flagstar Bank reported a 2nd quarter net loss of almost $75 million, following a first quarter 2011 net loss of almost $32 million, and a second quarter 2010 net loss of $97 million. The loss is attributed primarily attributed to “legacy balance sheet” issues. Flagstar has ramped up its commercial lending this year, which has helped, along with selling $68 million in non-performing commercial real estate assets. In the 2nd quarter “Mortgage rate-lock commitments increased $0.9 billion, or 16.8 percent, from prior quarter.”

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