FACTBOX-Brief U.S. default would roil financial system

NEW YORK, June 9 (Reuters) - Markets are anxious a U.S. default, even a brief one, would harm the country's stature among investors and spark another global financial crisis.

Wall Street sees the chance of default as close to nil, but a failure to increase the U.S. government's $14.3 trillion debt ceiling by Aug. 2 means it will be unable to make scheduled interest and principal payments.

Missed payments will shatter investor faith in Treasuries and trigger a global selloff in U.S. government debt. Because Treasuries are the benchmark for bonds worldwide, a stampede out of them could unleash a dramatic selling in stocks and other risky assets.

After the government reached its borrowing limit in mid-May, the Treasury Department took steps that have enabled the government to access cash in the meantime.

U.S. lawmakers are in a stalemate to reach a budget plan to rein in spending and pare its huge debt load. Contention over raising the debt ceiling is seen as a ploy by some in Congress to force the White House to deal with runaway spending. For more, see [ID:nN07154296]

Below are possible reactions in some key financial markets in case of a U.S. default in less than two months:

TREASURIES MARKET

The prevalent view is that a U.S. default will panic investors, prompting them to dump Treasuries and causing yields on government debt to soar.

The three major debt rating agencies warned that this event might constitute a "technical" default. If the United States misses more debt payments, they would consider taking away their AAA-rating on the United States.

Treasury yields are hovering near historic lows with the benchmark 10-year note's yield below 3 percent.

Robert Tipp, chief investment strategist at Prudential Fixed Income in Newark, New Jersey, estimates a brief U.S. default could raise long-dated yields by 0.4 to 0.5 percentage point from current levels.

MONEY MARKET MUTUAL FUNDS

Some analysts fear investors will pull out of money market funds if a U.S. default slashes the value of Treasuries, forcing their stock prices below $1 in a "break the buck" scenario.

This last happened to the Reserve Primary Fund in September 2008 shortly after the collapse of U.S. investment bank Lehman Brothers. Global funding activities nearly dried up after the Reserve Fund broke the buck.

This watershed event during the global credit crisis quickly resulted in unprecedented coordinated efforts among central banks to stimulate lending and contain the crisis.

Money market funds held $338 billion in mostly short-term Treasury securities at the end of the first quarter, according to Fed data. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Graphic - Largest holders of U.S. Treasuries r.reuters.com/juk99r Graphic - U.S. public debt outstanding versus debt ceiling since 1970 r.reuters.com/vyb59r Graphic - U.S. federal government debt and debt limit by year in the last three administrations, and the government's top ten foreign creditors link.reuters.com/kuj99r ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

GOVERNMENT DISRUPTION

The government's inability to issue new debt could cause a federal shutdown, resulting in a furlough of government workers and delayed payments to creditors, contractors and aid recipients. The last government shutdown occurred in 1995.

The following are some key payment dates shortly after the Aug. 2 debt ceiling deadline:

Aug 3: Monthly payment of $61 billion to 55 million Americans who receive Social Security.

Aug 4: $30 billion in Treasury bills mature.

Aug 11: $27 billion in T-bills mature.

Aug 15: $25.6 billion in quarterly interest payments on coupon-bearing Treasuries due.

FOREIGN CENTRAL BANKS

China and other countries have slowed their accumulation of Treasuries amid worries over government's heavy debt load. A U.S. default could cause this huge group of creditors to lose faith in owning Treasuries. Analysts worry a default will cause them to dump Treasuries outright.

Foreigners held $4.45 trillion in Treasuries at the end of March, of which 70 percent are held by overseas central banks. Overall foreign demand for Treasuries has fallen every month but one between September 2010 and March 2011, according to the U.S. Treasury Department.

Reduced overseas demand may be part of a broader attempt by central banks to diversify their dollar-heavy portfolios for fear an extended period of low U.S. interest rates will continue to erode the dollar's value.

Since January 2009, the dollar has lost 9 percent against a basket of major currencies .DXY.

China is the United States' biggest lender with $1.1 trillion in Treasuries at the end of March. Japan is second, with $908 billion in Treasuries, the latest Treasury data showed.

Each had Treasuries holdings smaller than those of the Federal Reserve, which had $1.56 trillion on June 8 after two rounds of bond purchases to help the U.S. economy.

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REPO RATES

A U.S. default would make it more expensive for banks and Wall Street dealers to raise money in the repurchase (repo) market. They rely on Treasuries to back repos for overnight cash for their investment and trading activities.

If Treasuries are perceived to be less credit-worthy, investors will charge commercial banks and investment houses higher rates on repos backed by Treasuries.

At the end of March, commercial banks held $302 billion in Treasuries and brokers/dealers $82 billion.

Next-day repo rate traded about 0.05 percentage point on Thursday, as persistent investor demand for Treasuries has resulted in near interest-free loans for banks and dealers to obtain overnight cash.

If a default damages confidence in Treasuries, however, repo rate will jump, making it expensive for banks to raise short-term funding.

The U.S. tri-party repo market was worth $1.6 trillion as of May 10, 2011. About 30 percent of those repos are backed by Treasuries, according to data collected by a group sponsored by the New York Federal Reserve.

INSURANCE/PENSION CLAIMS/MUTUAL FUNDS

Insurers, mutual funds and pension funds may struggle to meet claim payments and redemptions.

These investors hold Treasuries on the belief that they are safe investments and can easily sell them to raise money for payouts and redemptions.

At the end of the first quarter, life and property insurers owned a combined $249 billion in Treasuries.

Private pensions held $505 billion in Treasuries, while public ones owned $321 billion.

Mutual funds held $301 billion in U.S. government debt.

MORTGAGES, CONSUMER BORROWING COSTS

U.S. mortgage rates. business loans and other borrowing costs are linked directly and indirectly to Treasury yields. Any surge in federal loan costs will likely be more expensive for consumers and businesses to borrow.

Higher loan costs would curb already depressed home sales and prices. They may also reduce consumer spending that drives two-thirds of the U.S. economy.

The average rate on a 30-year fixed-rate mortgage, the most widely held type of home loan in the United States, slipped to 4.49 percent in the week ended June 9, according to Freddie Mac, as the benchmark 10-year note's yield fell below 3 percent for the first time in six months last week.

In December, the 30-year mortgage rate averaged 4.71 percent.

A spike in Treasury yields could lift the 30-year mortgage rate above 5 percent, a level not seen since April 2010. (Writing by Richard Leong. Additional reporting by Karen Brettell, Ellen Freilich and Steven C. Johnson; Editing by Kenneth Barry)