Amid another day of triple-digit losses for the Dow, U.S. financial firms are putting together plans for a worst-case scenario that involves a default on government debt and the resulting disruption to bond, credit and equities markets.
The Dow Jones Industrial Average has closed down on 11 of the past 14 trading days. On Sept. 18, the Dow closed at an all-time high of 15,676.94. Since then, the Dow has dropped 900.41 points to close today at 14,776.53.
Michelle Girard, an economist at RBS, says that her firm continues to believe that somehow the government will come to a solution to this debt ceiling crisis at the last minute, but RBS is still having non-stop meetings to test all sorts of systems to make sure that if there is a default it and other firms can function properly.
“What scares you is that you don’t know what you don’t know,” Girard said. Meaning that the markets are worried that despite all the planning and stress testing, there is a scenario that they haven’t planned for that can throw the system into turmoil.
Most firms are gaming out the worst-case scenarios, but Girard doesn’t believe that investors will truly start to panic until the deadline gets closer. In part that’s because, she says, “Investors feel like they have seen this movie before and know how the ending works.” She adds that the last few times the US had a fiscal crisis like this a last-minute deal was reached.
Girard also say the street may be a bit skeptical at this point too because the last couple of times Washington has screamed fire, it’s been a bit of a false alarm. In 2011 when US debt was downgraded by Standard & Poor’s, borrowing costs didn’t rise–in fact they fell and stocks recovered in a matter of months. And this past January the economy didn’t collapse when the sequester was put in place. So part of the conventional wisdom now is that the default may just be the government crying wolf again.
Still RBS and most every major firm are preparing for the worst,which would include no Social Security or entitlement payments across the board and a government default on some specific securities.