James Saft

James Saft is a Reuters columnist. The opinions expressed are his own.

If you are worried about the impact of a U.S. government shutdown on markets, you might just want to look past Treasuries and keep a weather eye on corporate bonds.

Investors will have good reason to dump U.S. corporate debt and shares in the event of a shutdown. Given that there are $29 trillion of corporate securities outstanding compared to only $9 trillion of Treasury debt in public hands some of those sales could flow into supposedly safer longer-term Treasuries even as corporate yields burst higher.

President Barack Obama proposed on Wednesday cutting the deficit by $4 trillion over 12 years, less than a week after Democrats and Republicans struck a last-minute stopgap deal to temporarily avert a government shutdown. Even so, the political divisions are deep and there are ample opportunities in coming months for impasse to lead on to nonpayment of bills, the sort of sort-of default that would doubtless send markets reeling.

“Markets will begin to anticipate a crisis,” said Rob Dugger, of Hanover Investment Group, a former partner in legendary hedge fund firm Tudor Investments.

“If government is forced into rapid adjustment it will be the private sector that gets hurt.”

The first thing to realize is that the budget situation has profoundly negative implications for the U.S. corporate sector, which will have to operate in an environment with less money floating around and with quite possibly a higher burden of taxation.

According to Dugger, some corporations and investors are already getting to grips with this, taking or planning steps to channel investment and income in ways to prepare for the cutbacks and avoid the worst of the tax increases. He is concerned that this takes on a momentum of its own, a force that could cause a sharp sell-off but would also retard long-term investment into the U.S.

The immediate risk is that a shutdown or threat of one sends a scare into investors, who having done the math on what this will mean for corporations, start to lighten up on the stocks and bonds of the companies that will be hurt worst. The kind of “herding” that often happens during a visceral news story will only make this worse.

As many investors have mandates to hold dollar-denominated securities, that could spark a flow out of corporate paper and into Treasuries, on the presumption that the U.S. will prove a good credit over time. In the absence of a massive fall in the dollar, the U.S. almost certainly will prove a good credit, and the costs of that will be spread across households and businesses.

UNACCOUNTED FOR LIABILITIES

Hanover Investment calculates that there is an unaccounted for liability of $2.459 trillion that should be on the balance sheets of U.S. corporations, this being their share of the current value of the government shortfall over 20 years.

Why does that shortfall matter to companies? Because they will share in the pain of higher taxes, lower government spending and all those two forces imply.

Is this a big deal for corporations? Given that the corporate share of the shortfall is 8.5 percent of total 2009 corporate book equity, it most certainly is a big deal.

Much depends on how much of that pain gets front-loaded, as opposed to spread over many years. If a lack of political consensus over how to tackle the budget brings on a crisis it will actually raise the risk of sudden and severe cutbacks, the kind seen in Greece or Ireland, as opposed to the more gentle adjustments the U.S., as the owner of a reserve currency and a AAA rating, should be able to achieve.

To be sure, much of this pain is inevitable; even with perfect cooperation in Washington and a following wind, there will still be cutbacks and those will still, all else being equal, make U.S. corporations less profitable and credit-worthy, at least in the short term. Quite aside from the near-term political risk, this unaccounted for liability faced by U.S. corporations is part of the argument for emerging markets, or for that matter for other developed markets that are in better fiscal shape, rare as they are.

Much may depend on how intransigent the two sides prove; what looks like standing up for principle (or playing to one’s political base) in Washington looks like self-defeating sand-throwing from Beijing or Berlin.

A lack of accord could make investors and executives begin to more radically and urgently discount the burden of future government cutbacks on corporations, causing a sell-off that would take on a momentum of its own.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

The revolving door between government and Wall Street is wrong, antithetical to both democracy and capitalism and ought to be stopped.

For the second time in two weeks a high-ranking recent U.S. public servant has traded a position of influence in the corridors of power for a massive paycheck working for an institution that owes its very existence to government largess.

This time it is Theo Lubke, who has transitioned smoothly from heading the New York Federal Reserve Bank’s derivative regulation effort to working for Goldman Sachs, where he can be expected to, well, help it do well out of regulation, current and future.

Last week it was Peter Orszag, who until July was the Obama administration’s Director of the Office of Management and Budget, joining Citigroup’s investment banking unit as a vice chairman. Several days before that Citi hired George W. Bush’s Commerce Secretary, Carlos Gutierrez, as vice chairman for its institutional clients group.

To be clear, none of the parties is doing anything illegal and there is no suggestion that any of them wittingly acted against the public interest while in government service.

That, however, is a very low standard and far from an argument for a system in which regulators and high-ranking political appointees oversee the financial industry while at the same time having a near guarantee of being in line to be made rich by it a short time after leaving office.

It would take an angel to stand aloof from that kind of money, especially after having rubbed shoulders for years with their better paid, better shod but not better qualified peers in banking.

Money gives people a warm fuzzy feeling, and so does the prospect of it; it is little wonder that financial regulation has been so loose and so poorly enforced.

And please, don’t tell me that the right to go and make a fortune in finance afterwards is the price a people must pay for the services of the most able policymakers. Larry Summers is a genius and Bob Rubin evidently the wonder of the world, but having them at the center of banking and regulation has hardly been a boon for either taxpayers or investors these past 15 years.

The United States would have been far better off, as it was until the 1980s, with a set of regulations so tight it could be administered by plodders and a banking industry peopled by able but unimaginative types making a decent living.

That, of course, would lower the rewards on offer in banking, both in terms of the money banks could produce and their motivation to offer it. And don’t believe that simple banking can be equated to simple medicine or technology; on the evidence growing complexity in financial services has hurt clients, shareholders and taxpayers, leaving the sole certain winner bank employees. Future bankers in public service have done rather well out of it too, you could say.

NUPTIAL LOGIC

The Orszag-Citigroup marriage is particularly striking, given that he was in the inner circle of an administration that made the controversial decision to keep the bank alive despite ample evidence that it richly deserved to fail. If that does not give you a queasy feeling, and on the evidence it did not for Orszag, consider that Citigroup is now the lucky owner of too-big-to-fail status, giving it an unfair advantage over smaller competitors who haven’t convinced those in power that they are indispensable.

Hanging on to the too-big-to-fail brass ring is arguably job 1 for Citigroup going forward and having someone with Orszag’s experience and, er, contacts is obviously useful. Gutierrez can be viewed as an insurance policy against the fickle winds of political fortune.

As for the Lubke-Goldman nuptials, the attractions and dowry are pretty much the same. While Lubke can’t claim credit for seeing Goldman through its rough patch during the crisis, he was, as head of the New York Fed’s Financial Infrastructure Department instrumental in derivative regulation reform efforts. He is reported to have pushed for on-exchange trading, a policy that is almost certainly against Goldman’s best interest, it must be said. As a former top Fed official he will be banned from any Fed-Goldman meetings or from contacting his former colleagues on matters in the area he once worked, according to Bloomberg News.

That is something, but not nearly enough.

It is all quite a contrast with Kansas City Fed President Thomas Hoenig, who asked by the New York Times about his plans after his coming retirement, said:

“I can tell you one thing. I’ll never work for a too-big-to-fail bank.”

Hoenig, cussed as he is, is a bit of an angel, and so may be Lubke, Orszag and Gutierrez, but depending on angels is a lousy policy.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)