Treasury(Default(=(Depression - Bitly

Thursday, October 03, 2013

Treasury(Default(=(Depression( ! Financially(Challenged(Legislators(Do(Not(Understand(

Richard X. Bove Vice President Equity Research Financial Sector [email protected] 813.388.2900!

(

!

Some(Unbelievable(Polls!

A!number!of!polls!are!now!underway!asking!the!American!people!whether!they!believe!a!default!on!U.S.!Treasury!debt!would!be!a! positive!or!negative!development.!!A!shockingly!high!number!of!Americans!–!50%!among!some!groups!A!think!that!it!would!be!good.!! Therefore,!this!comment!is!being!written!from!a!point!of!disbelief!that!there!would!actually!be!a!reason!to!write!it.! Treasury(Numbers! Pensioners! In!the!broadest!terms!the!Treasury!debt!of!the!United!States!is!owned!as!follows:! Breakdown Total Treasury Debt Holders Owned by Agencies of U.S. e.g., FICA Leaves Publicly Held Debt Owned by the FRB Leaves Treasuries Owned by the Private Sector Americans Foreigners Unaccounted for

Treasury Breakdown % Billions $16,738.3 100.0% $4,831.7 $11,906.6 $1,936.6 $9,970.0 $4,364.3 $5,600.6 $5.1

28.9% 71.1% 11.6% 59.6% 26.1% 33.5% 0.0%

! Looking!at!the!debt!in!its!broadest!terms,!it!is!immediately!apparent!that!the!largest!holders!of!this!debt!are!the!Social!Security!fund! and!other!government!agencies!and!pension!funds.!!Stopping!interest!payments!on!the!debt!and!preventing!the!refunding!of!this! obligation!would!ultimately!harm!everyone!on!Social!Security!plus!those!who!are!on!government!backed!pensions.!!! Federal!Reserve! According!to! Treasury!figures!the!Federal! Reserve!owned! $1.9!trillion!of!the!debt!at!the!end!of!the! second!quarter.!!The!Federal! Reserve!releases!at!the!end!of!June!2013!are!in!agreement!with!this!number.!!Treasury!Securities,!therefore,!back!54.5%!of!the!Fed! balance!sheet.!!A!default!in!the!Treasury!debt!would!cause!the!value!of!these!securities!to!plunge.!!This!would!raise!the!question!of! what!is!behind!the!value!of!the!dollar.!!Depending!on!the!size!of!the!decline!it!could!wipe!out!the!equity!at!the!Fed.!!At!the!end!of! June!the!Fed’s!equity!was!$63!billion!or!3.3%!of!the!size!of!the!Treasury!holdings.! These!numbers!ignore!the!Fed’s!ownership!of!Agency!and!mortgage!backed!securities!which!are!guaranteed!by!the!Treasury.!!They! equaled!$1.3!trillion.!!They!would!drop!in!value!in!line!with!the!Treasury!Securities.!!! Together!all!of!the!securities!noted!equaled!91.1%!of!Fed!assets!at!the!end!of!June.!!They!also!equaled!51!times!the!Fed’s!equity.! Federal(Reserve(Flow(of(Funds(Statistics! While!the!Treasury!numbers!are!the!most!authoritative!concerning!the!size!of!the!debt,!the!Federal!Reserve!publishes!its!own!set!of! statistics!to!represent!what!the!United!States!owes!(see!Table!on!following!page).!!The!FRB!numbers!do!not!include!Agency!holdings! of!Treasuries!so!this!amount!was!estimated.!!The!FRB,!however,!provides!a!better!breakdown!of!American!ownership!of!Treasury! debt.! Households! The! first! data! point! that! catches! the! eye! is! the! amount! of! Treasury! debt! owned! by! American! households.! ! It! equals! $1.2! trillion.!! Defaulting!on!the!debt!would!immediately!impact!the!interest!payments!on!these!funds.! ! ! ! PLEASE SEE IMPORTANT DISCLOSURE AND ANALYST CERTIFICATION LOCATED IN THE APPENDIX OF THIS REPORT.!

Thursday, October 03, 2013

Treasury(Default(=(Depression( ! A!broader!analysis!shows!the!following:! Breakdown Es timated Total Treas ury Debt Holders Es t. Owned by Agencies of U.S. e.g., FICA Leaves Publicly Held Debt Owned by the Federal Res erve Leaves Treas uries Owned by the Private Sector Americans Households Businesses State & Local Governments Depository Institutions Insurance Companies Pension Funds Money Mark et Mutual Funds Investment Funds GSEs ABS Issuers Brok ers & Dealers HoldingCompanies Total Americans Foreigners Unaccounted for

FRB Breakdown Billions % $16,744.6 100.0% $4,831.7 $11,912.9 $1,936.6 $9,976.3

28.9% 71.1% 11.6% 59.6%

$1,192.8 $97.8 $526.6 $194.0 $261.0 $720.0 $449.0 $539.6 $75.5 $21.2 $165.6 $20.9 $4,264.0 $5,600.6 $111.7

7.1% 0.6% 3.1% 1.2% 1.6% 4.3% 2.7% 3.2% 0.5% 0.1% 1.0% 0.1% 25.5% 33.4% 0.7%

!

Funds! It!is!not!my!intention!to!comment!on!every!sector!shown!in!the!above!table.!!However,!a!few!require!special!mention.! Money&Market&Mutual&Funds! Should!the!United!States!government!default!virtually!every!money!market!mutual!fund!(MMMF)!in!the!country!would!“breakAtheA buck”!–!i.e.,!be!unable!to!pay!investors!100!cents!on!every!dollar!invested.!!At!present,!MMMFs!that!do!not!actually!earn!enough! money!to!pay!back!100!cents!on!the!dollar!are!subsidized!by!the!fund!management!company.!!A!Treasury!default!would!make!this! virtually!impossible!and!millions!of!Americans!would!lose!billions!of!dollars.! Mutual&Funds! The!indentures!of!most!bond!and!balanced!mutual!funds!require!that!they!immediately!divest!their!holdings!of!defaulted!securities.!! This!could!cause!hundreds!of!billions!in!Treasuries!to!be!sold!immediately!when!the!default!was!announced.! Depository!Institutions! Let’s!shift!to!another!government!document.!!This!would!be!the!FDIC’s!aggregate!balance!sheet!of!the!American!banking!industry.!! Here!are!some!data!points:! FDICAInsured!American!banks!own!$166!billion!in!Treasury!securities!(the!FRB!claims!$194!billion).! They! own! an! estimated! $1.68! trillion! in! agency! guaranteed! debt! (the! FRB! claims! they! own! a! bit! more! than! that! $1.73! trillion).! A!reasonable!estimate!would!be!that!the!U.S.!banking!industry!owns! $1.85!trillion!in!government!backed! securities.!!It!has!$1.63! trillion!in!equity.!!If!the!Treasury!and!related!securities!were!in!default,!one!does!not!know!what!they!would!be!worth.!!Assume!a! Latin!American!valuation!of!10!to!20!cents!on!the!dollar!and!an!estimated!$1.28!trillion!in!U.S.!banking!equity!would!be!wiped!out.! If!you!think!this!is!an!extreme!assumption,!consider!the!following:! In!addition!to!the!U.S.!backed!securities!the!banks!own,!they!own!an!additional!$1.27!trillion!in!other!securities!that!would! plunge!in!value.! They!have! $7.73!trillion!in!loans!which!would!also!fall!in! value.!!Moreover,!some!unknown!number!of!the!loans!are!also! guaranteed!by!the!U.S.!government!–!e.g.,!FHA!and!VA!mortgages.!

PLEASE SEE IMPORTANT DISCLOSURE AND ANALYST CERTIFICATION LOCATED IN THE APPENDIX OF THIS REPORT.!

Thursday, October 03, 2013

Treasury(Default(=(Depression( ! It!is!my!strong!belief!that!a!true!default!by!the!United!States!Treasury!would!wipe!out!bank!equity.!!All!bank!lending!to!the!private! sector! in! the! United! States! would! stop,! immediately.! ! Existing! loans! would! not! be! rolled! over.! ! Immediate! repayment! would! be! demanded.! Foreign!Debt! Both!the!Treasury!and!the!Federal!Reserve!agree!that!foreign!entities!own!$5.6!trillion!of!Treasury!debt.!!Let’s!take!a!closer!look! here.! Countries China Japan OPEC Caribbean Banking Brazil United Kingdom Russia Luxembourg Taiwan Hong Kong Switzerland All Other Totals

Treasury Breakdown Billions % $1,275.8 22.8% $1,083.4 19.3% $256.8 4.6% $290.8 5.2% $253.7 4.5% $162.6 2.9% $138.0 2.5% $150.6 2.7% $186.2 3.3% $124.2 2.2% $180.4 3.2% $1,498.1 26.7% $5,600.6 100.0% !

A! default! by! the! Treasury! would! create! real! problems! for! these! countries! –! problems! that! go! well! beyond! losing! money! on! the! Treasuries!that!they!hold.!!Let’s!use!China!as!an!example.!!With!Hong!Kong,!it!owns!$1.4!trillion!in!U.S.!debt!or!25.0%!of!all!foreign! ownership!and!11.6%!of!all!U.S.!public!debt.! The! International! Monetary! Fund! counts! all! $1.4! trillion! as! reserves! at! China’s! central! bank.! ! By! my! estimate! this! means! that! approximately!41%!of!China’s!$3.4!trillion!in!reserves!are!backed!by!U.S.!Treasuries.!!A!decline!in!the!value!of!Treasuries!due!to!a!U.S.! default!would!have!a!similar!impact!on!the!value!of!China’s!currency!as!it!would!in!theory!have!on!the!U.S.!dollar.! Reserve(Currency!( To!this!point!this!whole!discussion!is!theoretical.!!What!is!not!theoretical!is!that!the!discussion!of!the!possibility!that!the!U.S.!would! actually!default!has!a!real!impact!on!every!country!in!the!world!that!holds!Treasuries.!!It!tells!them!as!clear!as!can!be!that!they!are!at! risk.!!The!reserves!in!their!central!banks!are!not!based!on!a!nation!with!a!stable!and!secure!economy.!!The!value!of!their!reserves!is! be!based!on!an!erratic!and!politically!charged!government!that!may!destabilize!their!central!banks!and!they!cannot!stop!it.! The!message!is!clear.!!Do!not!put!yourself!at!risk!to!this!government.!!Get!rid!of!Treasuries!and!substitute!them!for!other!currencies! or!securities.!!This!would!end!the!U.S.!dollar’s!reign!as!the!world’s!only!reserve!currency!and!it!would!force!the!U.S!to!actually!repay! its!debt.! Conclusion! It!is!actually!shocking!that!I!would!write!a!comment!of!this!nature.!!The!devastation!to!the!United!States!would!be!so!severe!that!it! would! take! decades! to! recover! from! the! Depression! caused! by! a! default! and! the! attendant!dumping! of! trillions! of! dollars! of! U.S.! Treasury!securities!on!the!global!financial!markets.!!! One!would!think!that!the!impact!would!be!so!devastating!that!it!would!be!unthinkable.!!Yet,!this!comment!is!being!written!because! polls! are! suggesting! that! a! large! number! of! Americans! and! many! in! Congress! actually! believe! that! a! Treasury! default! could! be! positive.!!!!!Moreover,!the!media!is!still!trying!to!grasp!how!to!deal!with!this!story.!!It!has!entered!the!national!debate.! Note:(Please(be(aware(that(the(numbers(in(this(comment(grossly(understate(the(actual(obligations(of(the(United(States(government.((For(example,(the(GSE(debt( and(guarantees(is(believed(to(equal($7.6(trillion(on(top(of(the($16.7(trillion(the(U.S.(owes.((Moreover,(there(is(no(number(provided(for(all(of(the(debt(guaranteed( by(the(U.S.(outside(the(mortgage(sector.((It(is(also(in(the(trillions.( God(spare(us(from(the(fools(who(lead(us.!!

! PLEASE SEE IMPORTANT DISCLOSURE AND ANALYST CERTIFICATION LOCATED IN THE APPENDIX OF THIS REPORT.!

Thursday, October 03, 2013

Treasury(Default(=(Depression( ! Financial Analyst

Institutional Sales ( Richard X. Bove Joseph Bove Vice President Equity Research Vice President Institutional [email protected] Sales 813.388.2900 [email protected] 646.572.3378( Appendix: Analyst Certification and Other Important Disclosures (

Ed Bugniazet Managing Director [email protected] 646.572.3389(

( Ed Perley [email protected] 646.572.3386(

Analyst Certification I, Richard X. Bove, certify that with respect to each security or issuer that I covered in this report; (1) all of the views expressed accurately reflect my personal views about those securities or issuers; and (2) no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by me in this research report. Regulatory Disclosures Analyst Stock Ratings Definitions Rafferty Capital Markets’ (“RCM”) ratings, effective January 2, 2013, are defined as follows: Buy – A stock that at initiation displays projected Price-to-Book ratio less than 100% and projected Earnings Direction greater than zero. The rating may be maintained following initiation as long as it is deemed appropriate, notwithstanding price fluctuations that would cause the rating to fall outside of the above parameters. Hold – A stock that at initiation displays projected Price-to-Book ratio less than 100% and projected Earnings Direction less than zero; projected Price-to-Book ratio between 100% and 200% and projected Earnings direction less than 10%; or projected Price-to-Book ratio greater than 200% and projected Earnings Direction greater than 10%. Sell – A stock that at initiation displays Projected Price-to-Book ratio greater than 100% and projected Earnings Direction less than zero. The rating may be maintained following initiation as long as it is deemed appropriate, notwithstanding price fluctuations that would cause the rating to fall outside of the above parameters. Distribution of Ratings RCM must disclose in each research report the percentage of all securities rated by the member to which the member would assign a "buy", "neutral" or "sell" rating. The said ratings are updated on a quarterly basis. Below is the distribution of RCM’s research recommendations: Buy: 64.5% Hold: 32.3% Sell: 3.2% There are 31 stocks under coverage Market Ratings Negative – A 10% expected decline in S & P 500. Neutral – The S & P is expected to trade within 10% bounds up or down. Positive – A 10% expected rise in the S & P 500. Valuation and Risks The primary risks to achieving our target price include general market fluctuations, unexpected shifts in economic activities, and/or unexpected reversals in company fortunes. Additional Information is Available upon Request to Barbara Martens at Rafferty Capital Markets, LLC, 1010 Franklin Avenue, Garden City, NY 11530 or 516.535.3800 PLEASE SEE IMPORTANT DISCLOSURE AND ANALYST CERTIFICATION LOCATED IN THE APPENDIX OF THIS REPORT.!

Thursday, October 03, 2013

Treasury(Default(=(Depression( ! Other Disclosures Rafferty Capital Markets ("RCM") is an institutional brokerage firm that does not engage in investment banking. RCM and its affiliates, including its principals, may own securities of the companies which are subject of this report but do not own 1% or more of any class of common equity securities of any subject company. The information and opinions presented in this report are provided for informational purposes only and are not to be used or considered as an offer or solicitation of an offer to buy or sell securities or other financial instruments. RCM has not taken any steps to ensure that the securities referred to in this report are suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about any such investment. Information and opinions presented in this report have been obtained or derived from sources believed by RCM to be reliable, but RCM makes no representation as to their accuracy, timeliness or completeness. RCM accepts no liability for loss arising from the use of the information presented in this report. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information and opinions contained in this report reflect a judgment at its original date of publication by RCM and are subject to change without notice. RCM may have issued, and may in the future issue, other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them and RCM is under no obligation to insure that such other reports are brought to the attention of any recipient of this report. This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject RCM to any registration or licensing requirement within such jurisdiction. All material presented in this report is the property of RCM and is under copyright to RCM. This report may not be reproduced, distributed or published by any person for any purpose without the prior express written consent of RCM. ( ( (

(

PLEASE SEE IMPORTANT DISCLOSURE AND ANALYST CERTIFICATION LOCATED IN THE APPENDIX OF THIS REPORT.!