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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Answers to the 5 big "what-ifs" of debt default Reuters

Answers to the 5 big "what-ifs" of debt default Reuters

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windi5

windi5
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The debt negotiations are getting down to the wire. Republican and
Democratic lawmakers are scrambling to broker a deal to raise the
country's $14.3 trillion debt ceiling before Tuesday, when the Treasury
will no longer be able to borrow funds to meet all of its obligations.
It all means the United States could face the possibility of defaulting
on its debt and losing its prized triple-A credit rating.

Here are some answers we compiled from Reuters Money experts:

1.Will interest rates on mortgages, car loans, student loans and credit cards rise? Yes. Like any average Joe or Jane
who misses a credit card payment, the United States will be socked with
higher borrowing costs if it defaults on its debt. If the country loses
its coveted triple-A rating, which is expected to happen, the cost to
service its debt will probably rise. And that will have a significant
ripple effect.

Greg McBride, senior financial
analyst at Bankrate.com, says either a ratings downgrade or debt default
would result in higher borrowing rates for consumers and businesses
alike. "More of a concern is that a prolonged default could cause credit
markets to freeze altogether, and we will have real problems," he says.

It's impossible to speculate how
much rates will go up, he says. "There are a lot of variables at play.
The downgrade will lead to a more modest increase in rates. However,
that increase would be permanent." Folks who have variable debt such as a
credit card balance or adjustable-rate mortgage can take a little
comfort in this: "You are going to see higher interest rates eventually,
anyway, because rates are so low," McBride says.

Alas, consumers won't see higher
rates on saving products, such as certificates of deposit or money
market accounts. "Those products won't improve until loan demand picks
up; any downgrade or default will only hold back loan demand," McBride
says.

2. What's the outlook for the U.S. dollar?

Fear that the United States will
lose its AAA credit rating or even default on its debt is driving
foreigners away from U.S. assets, and the dollar is taking the biggest
hit.

Recent trading in currency markets indicates overseas investors have
been voting with their feet. They have also been giving short shrift to
recent Treasury auctions.

Traders say Asian central banks, among the world's biggest dollar
holders, have been steady buyers of alternatives to the dollar such as
the Singapore dollar and other Asian currencies as well as the Canadian,
Australian and New Zealand dollars. "Foreigners are at the vanguard of
the drop in the dollar," says Dan Dorrow, head of research at Faros
Trading, a currency broker/dealer in Stamford, Connecticut. "I don't
think anyone expects a catastrophic U.S. default. But a downgrade will
make them more aggressive in moving away from the dollar."

If global investors lose faith in the dollar, that could weaken its
dominant position in global trade and its role as the world's reserve
currency. Over time, diminished demand for dollars would make it harder
for the United States to finance itself at low interest rates.

The bottom line? It will be more expensive to travel overseas, drink French wine or buy Japanese cars.

3. What's the outlook for U.S. Treasuries?

The Treasury market has held up better than the dollar, but bonds
haven't been let off the hook entirely. Foreigners, who hold nearly half
of outstanding Treasury debt, have been less active buyers at auctions
this month. Still, the 10-year yield has held below three percent for
most of July, less than a percentage point from its multi-decade low.

That's partly because domestic investors have picked up the slack in
recent debt sales, suggesting they see no alternative to U.S. government
bonds even in the face of a default or possible downgrade.

Indeed, analysts say even with a downgrade, Treasuries would remain
the benchmark for world fixed income markets, as Fitch Ratings noted
this week.

Terry Belton, global head of fixed income strategy at JPMorgan Chase,
said a downgrade would probably add just five to 10 basis points to
yields in the short run. But it could cost the U.S. government up to 70
basis points, or about $100 billion, in added borrowing costs over time
as foreigners look to invest their money elsewhere.

4. Will we still pay our soldiers?

While a group of Congressmen pushed
forward a bill this week to ensure that the active military servicemen
still get paid in the case of default, there's no firm plan yet. The
White House hasn't made any assurances and either has the Treasury
Department. Some financial organizations that service military clients,
like USAA and the Andrews Federal Credit Union, have stepped up to say
that they will advance pay if there is a default. "Rest assured, USAA
has continued to manage its financial resources to meet our commitments
to members in their moments of need," says CEO Joe Robles in a
statement.

What will a default actually mean for military members and their
families? "The bigger concern has got to be interest rates," says Sarah
Gilbert, the wife of an army reservist and a personal finance writer who
was formerly an investment banker. She says military families have been
through pay stoppages before - during the last government shut-down,
they actually halted all military pay a week early - but what will
really hurt is if interest rates go up even a little bit. "There's no
wiggle room," she says. "Military families are so dependent on debt
because they have to move so much, they are living on small budgets and
they are mostly young families that don't have a lot of established
savings. If interest rates go up, you're looking at foreclosures,
collections and not being able to pay bills."

5. Is there an upside to higher interest rates?

Barry Glassman, president and
certified financial planner at Glassman Wealth Services in McLean,
Virginia, says higher interest rates are good for retirees and folks who
have fixed mortgages. "I don't know anyone with a five-year Treasury
bond who doesn't believe they won't get their interest and principal
back. If yields do jump, my clients would love 10- year Treasuries with a
five percent coupon," Glassman says.

But McBride of Bankrate.com says it's going to be a bumpy ride for
most folks. "There are no winners here. Your best bet is to sit tight
and pull the seat belt a little tighter," he says.

(With reporting from Mark Miller, Steven Johnson, Beth Pinsker and Linda Stern.)

Antonym

Antonym
Vice President - Equity Analytics
Vice President - Equity Analytics

Breaking News: US Leaders Approve Debt-Limit Increase

http://www.bloomberg.com/news/2011-07-31/white-house-republicans-said-to-reach-tentative-deal-on-u-s-debt-ceiling.html

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