Banks Fear Damage of U.S. Debt Default

NEW YORK (MainStreet) — Banks are preparing for the worst. If the U.S. government is unable to come to terms and the nation defaults on its debt, they will be sailing in uncharted waters. Financial executives are already huddling in "war rooms" to discuss strategy, while stockpiling cash reserves to cover possible consumer reaction.

The Financial Times reports one senior bank executive as saying his bank was delivering 20% to 30% more cash than usual to branches and ATMs just in case "panicked customers" try to withdraw funds in a rush. The Federal Deposit Insurance Corp. insures deposits up to $250,000.

"Banks are also holding daily emergency meetings to discuss other steps, including possible free overdrafts for customers reliant on Social Security payments from the government," the report says.

The just-released World Economic Outlook issued by the International Monetary Fund, also presents a somber, cautionary view.

"While the damage to the U.S. economy from a short shutdown is likely to be limited, a longer shutdown would be quite harmful," the IMF says. "And even more importantly, a failure to promptly raise the debt ceiling, leading to a U.S. selective default, could seriously damage the global economy."

Rob Nichols, the president and chief executive of the nonpartisan Financial Services Forum, has said the result of a debt-ceiling default could potentially be worse than the events triggered by the failure of Lehman Brothers in 2008.

"All of the consequences of an actual default are just severe and unfathomable and unthinkable," Nichols told American Banker. "If we were to default on our debt, that would probably spook investors, which would dry up overnight lending. You would imagine that accompanying that sort of event, we would be downgraded, which probably would lead to a sharp spike in rates, which would have its own drag on the economy."

Short-term lending, interest rates and money market mutual funds could all suffer, Nichols claims.

"Banks would be dealing with a host of mechanical issues that they've never had to deal with before, coupled with the broader macroeconomic impacts," Nichols added. "There would also just be real fear on the part of investors to continue investing in the United States while we've made a judgment to stop paying" some obligations.

— By Hal M. Bundrick for MainStreet

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