TIME: Today’s Greatest Enemy of Wall Street

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3:50 PM EST KRAMES UPDATE: I have been closely listening to several members of Congress today. And I must say that there are a few things that do not sit right with me. Why? Could it be that with about eight (8) hours remaining before the default deadline, few senators have actually read the bill that Reid and McConnell have cooked up? That might seem trivial, but what if there is something in there that turns off some members in either chamber—on either side of the aisle? Also, the timing is not what we were led to believe earlier in the day. We expected an afternoon Senate vote, but now it is not until this “evening,” or “after dinner.” This evening—you mean tonight? That is cutting things razor-thin close—especially when the House has yet to weigh in and will only do so until AFTER the Senate passes the bill. House Leader Boehner needs 117 votes to garner a majority of the majority, and I don’t see him getting much more than 100. There appears to be a deal here, but there is still some room, albeit quite small, for miscalculation. Now, we may see another strong rally in the Dow—just before the close or tomorrow—but we are up about 600 points since last Wednesday. In my mind, that means that there is little to no room for miscalculation or error. And that potential Fitch downgrade still sits in the pit of my stomach.

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12:40 PM EST, KRAMES UPDATE: Senator Ted Cruz, the architect of the government shutdown, just gave a speech that indicated that he would not stand in the way of the Senate bill (any other option for him would have ended his career, but that is besides the point). This clears the way for the Senate to take up the bill first (which was in doubt, due to procedural matters), and then pass it to John Boehner in the House. Most House Republicans are expected to vote it down but there will be enough moderate GOP members to allow the bill to pass both chambers of Congress and have it signed by the President by midnight. This was baked into the cake already so we saw a little sell-off but the market is still showing strength—up about 190 points. The test will be if this turns out to be a “buy the rumor, sell the news” close. I also fear that Fitch downgrade which I feel in my gut is coming. This “management by crisis” is no way to run any organization, particularly the largest in the world. We are not going to escape this entire fiasco without some damage. Who knows how many jobs and how many tenths of GNP this shutdown—and a near-default—cost us?
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10:45 AM EST, KRAMES UPDATE: As predicted earlier, it was announced that John Boehner will cooperate with the Senate deal. That means he will almost assuredly put any bill on the floor, with the full knowledge that it will be the Democrats that secure the vote withsome help from moderate Republicans. No FINAL deal in the Senate has yet been announced, but the Senate will be meeting to discuss this at 11:00 AM EST. Markets shrugged off the news.

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KRAMES UPDATE: 10:22 AM EST. Word has come that a deal is about to be announced out of the Senate, which is what doubled the Dow’s gain. But that announcement came an hour ago. And today, an hour is a big deal. I still assert that even if a deal is reached today—and there is no certainty they will make the deadline—that this is way too close a call for Fitch. At some point, this is very likely to cause a downgrade, which will have real consequences on financial markets, etc.
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For those of you new to my blog—especially to my fellow Zack’s members—Welcome!

If you have a few minutes, you might want to scroll down and skim a few of my recent blogs on the Beltway disaster and how we have arrived at the most dangerous moment since the Lehman Brothers bankruptcy. moment.

My goal in writing these “Inside-the-Beltway” pieces [and updates] will be to bring you everything I know as I learn it in real time: so today especially, please be sure to check back here every few hours for the latest “Default News” as it is breaking. However, the more reliable indicator of how things are progressing will be the financial markets, as always.

As my good friend Kevin Cook pointed out last night, I have been obsessed with the absolute dysfunction that has been plaguing our government this last month. The optics simply could not have been worse, which is precisely why late Tuesday afternoon credit agency Fitch announced that the U.S. is now on credit rating watch “negative.”

While a “watch” itself is not a downgrade—and important distinction—I believe that Fitch will indeed downgrade the United States, and likely sooner than later. That is key because the market lost about $1 trillion in stock market value the last—and only time—we were downgraded [by Standard & Poor’s in August of 2011 for the very same reason—failure to raise the debt ceiling in an orderly and timely manner]. The greatest difference between now and then is that today is much worse.

Why? For two reasons:

1. This time, we have a better than 50 percent chance of breaching the Debt Ceiling midnight deadline; and,

2. The perception of the U.S. as a reliable and fiscally safe global economy is diminishing. You only have to read about what is being said/written about the U.S. in other countries to see how fiscal confidence in the U.S. is eroding by the day (and, in these last few days, by the hour).

For example, China, which holds $1.28 trillion in U.S. debt, recently came out strongly against the United States, something that is largely unprecedented for the usually “quiet” far-Eastern country. The China state news agency broke its silence and urged other nations to “rely less” on the United States:

As U.S. politicians of both political parties are still shuffling back and forth between the White House and the Capitol Hill without striking a viable deal to bring normality to the body politic they brag about, it is perhaps a good time for the befuddled world to start considering building a de-Americanized world

I cannot over-emphasize the importance of that pronouncement, especially now, with only about 18 hours to go before the U.S. defaults. Again, it is not China’s way to issue any kind of pronouncement on other countries, especially one this negative in tone (in far Eastern countries it is considered disrespectful). That is why I think it is so critical that China did this. The U.S. dollar is not only the currency of America, it is the world’s currency. And if China and other vital countries believe that it is not in their best interest to hold this much American debt, the results could have a dramatic and swift effect on our financial markets.

It is interesting to note that China is not the largest holder of U.S. debt. The Federal Reserve is. They hold a third of U.S. debt (not necessarily a good thing), China holds 22 percent, and Japan 19 percent. So watch for any more pronouncements from China and/or Japan—as they could telegraph any negative moves that might trigger additional problems for our economy (I will also stay on top of those and let you know if we see any of that in the coming days).

Let’s switch gears for a moment and review exactly why we stand on the precipice of default today. About a month ago I wrote how dangerous it was for Speaker of the House Boehner to “delegate his leadership to Tea Party leader and Texas Senator Ted Cruz.”

Leadership always plays a role in times of crisis, and I have always argued that leadership is one thing that should never be delegated. Once Boehner gave the keys to “his” House to Cruz, the seeds of the shutdown and an ultimate default were sown (which is why I hold a great number of shorts in my portfolio to this day). Look at what happened as a result. Some pundits are comparing the U.S. House to a “failed nation state.” It is a leaderless morass of people at odds with each other with one particular faction eager to wreak as much havoc as possible.

However, leadership, especially in times of crisis, can be regained, and can be the vital instrument that can diffuse a crisis and avert ultimate disaster. In other words, there is still an opportunity for Boehner to play a decisive role in helping the U.S. to right its ship, at least in part. However, the problem is time. At the time of this writing, it does not appear to me that there is enough time for us to get a bill written and passed by both chambers of Congress and signed by the president to raise the debt ceiling by midnight tonight. I could be wrong, but at the very least it will be too close to avert a Fitch downgrade. If it fails to be signed by midnight, it is because there are too many moving parts to get every piece in place in time.

Now, if we fail to have a signed bill by midnight, no one knows what that means. Some say, since the Treasury still has about $30 billion in its coffers, that it is no big deal. I think otherwise, for a myriad of reasons. But here are the key dates that will come into play should we breach the critical midnight deadline:

Key Dates
October 17th at 12:01 a.m. the U.S. Treasury runs out of short-term funding maneuvers and loses its authority to borrow money (and for those congressional leaders who say this is not a big deal are sadly misinformed).

October 22nd: The Congressional Budget Office (CBO) runs out of its last $30 billion (which is what it estimates to have left on the 17th, and starts to miss payments).

October 23rd: $12 billion in Social Security payments are slated to go out.

October 31st: Congressional Budget Office (CBO) expects to have exhausted any cash remaining on hand. A $6 billion interest payment is due on that same day.

November 1st: $55 billion in Medicare, Social Security and military checks are “scheduled” to go out.

These dates show why some congressional members say that the 17th is not “default day.” Technically that is true; but it is the perception of what happens on the 17th that is so critical, and not only here, but around the globe.

What to Expect Today
The Senate will try to cobble together a final deal and commit it to paper (Reid and McConnell should never have stopped negotiating yesterday when Boehner said he was entering the fray, but that is water under the bridge). The Senate will hope to vote on the bill sometime this afternoon and if passed (and that is not a slam dunk), it will go over to the House. That is the moment of truth: will Boehner, knowing that only a minority of Republicans will vote on it, put it on the floor? This is where the House “Leader” can get back some semblance of leadership. I believe he will. He will finally do what he should have done before the government shutdown: tell the Cruz-controlled faction to shut up, sit down, and explain that we have done everything we could, and now the country must come first. If he puts it on the floor, it will get most—or all Democrats—and enough Republicans for the bill to pass. That to me is the most likely path.

What Could Go Wrong?
Ted Cruz could go wrong. If he—or any Senator chooses to object in the Senate—game over. That will spark a large enough delay for us to miss the midnight deadline. I find it ironic that in this great experiment that is Democracy that one man can bring the largest economy–even the global economy—to its knees.

Lastly, we end where we begin. The clock could go wrong. It can keep ticking past the hour of midnight. But at this moment the market expects a deal: the futures are up nicely, expecting a pre-midnight deal. Only time will tell.

Things can change quickly so stay tuned for updates later today!
—Jeffrey A. Krames, October 16th, 2013, 7:15 a.m.

DEFAULT TRIVIA
It may be comforting to some of us that the U.S., should they default, will not be the first:

Russia defaulted in 1998 to the tune of $40 billion, causing some investors to pull money out of emerging markets.

In late 2001, following three years of economic contraction, Argentina defaulted on $95 billion of its debt obligations. Argentines pulled out $10 billion out of banks in six months.

In 2012, Greece beat them all by “restructuring” $270 billion in bonds—a new record that stands to this day.

Let us hope that we do not grab the world record from Greece in the days ahead!!

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