–Fed Off’l:Uncertainty On Whether US Govt Credit Risk Underestimated

By Yali N’Diaye

WASHINGTON (MNI) – U.S. regulators told lawmakers Wednesday that
while a downgrade of the U.S. sovereign rating could happen, its impact
is difficult to assess.

In other comments during a House Financial Services Committee
hearing on ‘Oversight of the Credit Rating Agencies Post Dodd-Frank,’
regulators repeated the challenges of finding adequate replacements to
rating agencies in regulations.

The general nervousness about the fate of the AAA rating of the
U.S. government debt is mounting as the debt ceiling and deficit
reduction debate is still going on.

So some lawmakers questioned the regulators about the potential
impact of a U.S. downgrade.

Witnesses at the hearing included Federal Reserve Division of
Banking Supervision and Regulation Senior Associate Director Mark Van
Der Weide, Office of the Comptroller of the Currency Senior Deputy
Comptroller and Chief National Bank Examiner David Wilson as well as
Securities Exchange Commission Division of Trading and Markets Deputy
Director John Ramsay.

Rep. Brad Miller in particular reminded the importance of U.S.
Treasuries as a collateral in the repo and the derivatives markets.

“If our debt is downgraded,” he asked, what would be the effect on
the repo market and the use of Treasuries as collateral in this market?

OCC’s Wilson was the only one to take a chance at answering.

“It is something that we have considered,” Wilson said.

“The best guess is that there would be an adjustment of the margin
required, so you wouldn’t be able to borrow as much through the repo
market.”

Still, he continued, “We think that that’s manageable in the short
term because even, for example, going from a AAA to a AA, you still have
a very high quality security and it’s still considered one of the safest
instruments in the world.”

“But who knows what will happen long term,” he said.

Asked about other forms of debt, Wilson said it would probably have
ripple effects. “The extent of it,” however, “is hard to measure.”

Fed’s Van Der Weide, however, stressed that the borrowers in the
repo market today are much better capitalized than they were going into
the crisis.

“There is also a new regulatory framework that’s coming,” he
said, referring to the new Basel liquidity and capital requirements “to
make that repo market safer, sounder and more stable.”

Answering about a question on the impact of a downgrade of the U.S.
sovereign debt on money market funds, SEC’s Ramsay said MMFs are in the
process of looking at their own investment guidelines.

Still, “Am I right to worry?” asked Miller, about a U.S. sovereign
debt downgrade.

“It’s hard to measure but I think you’re right to worry,” Wilson
said, adding, “it could happen.”

He insisted, however, that “It’s very difficult to assess the
impact.”

Lawmakers also questioned whether the risk on the U.S. government
debt is actually being underestimated.

“I think there is a fair amount of uncertainty,” Fed’s Van Der
Weide conceded.

The hearing otherwise mostly focused on Dodd-Frank implementation,
especially the removal of credit references from regulations and
overreliance by the private sector.

The Fed officials highlighted that among challenges that are
delaying action, finding a transparent and appropriate substitute is
simply difficult.

But the Fed is definitely working on finding a definition to
creditworthiness, Van Der Weide said, with a focus on capital rules.

He added that it is also an interagency process, adding to
the overall complexity.

Another complication is the existing Basel III capital framework
that includes references to ratings.

Still, while there is no concrete proposal at this stage, Van Der
Weide expects one “in the near future.”

** Market News International Washington Bureau: 202-371-2121 **

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