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Financial firms ponder options should US default

“Hopefully, clearer heads will prevail, and we can avoid this crisis.” said David Cotney, the Massachusetts commissioner of banks. “Hopefully, clearer heads will prevail, and we can avoid this crisis.” said David Cotney, the Massachusetts commissioner of banks. (Kayana Szymczak for The Globe)
By Todd Wallack
Globe Staff / July 27, 2011

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Financial institutions across the country were reviewing their holdings, preparing contingency plans, and working to calm anxious investors as the government moved another day closer to defaulting on its financial obligations.

While most banks and investment firms expect Congress to strike a deal, they are nonetheless preparing for what might happen if lawmakers fail to lift the debt ceiling and avoid a default by next week’s deadline.

Fidelity Investments in Boston, for example, has performed so-called stress tests on its money market holdings to be sure they could withstand the fallout from a default.

Rockland Trust, a community bank south of Boston, said it plans to waive overdraft fees for customers affected if the government stops paying Social Security and other benefits.

Major banks, including Bank of America, TD Bank, Sovereign Bank, Wells Fargo, and Citibank, are all drafting contingency plans, though they declined to disclose details.

“This is not an unknown. This is something that banks have had weeks and months to prepare for,’’ said banking analyst Nancy Bush. “It’s been a slow-moving train wreck.’’

For weeks, President Obama and congressional Republicans have tangled over a deficit-reduction package, which has become a prerequisite for raising the statutory debt limit, expected to be reached Aug. 2.

If Congress fails to raise the limit, the government would be unable to borrow to meet its obligations, resulting in a technical default, and provoking what many analysts say would be another financial and economic crisis.

Both Republican and Democratic leaders say they want to avoid a default and, so far, financial markets have signaled they believe they will. Stocks have declined in each of the past three days, but there has not been panic selling. Investors are still buying US Treasury bonds, and their interests rates fell yesterday, a sign buyers still see them as safe.

“Americans believe there is going to be a resolution,’’ said John Hailer, who runs the US and Asia operations of Natixis Global Asset Management, which owns investment companies, including Loomis Sayles & Co. in Boston. “I think it will be an unbelievable shock to Americans if Washington doesn’t come up with something.’’

Two of the nation’s largest mutual fund companies, Fidelity Investments and Vanguard Group, of Valley Forge, Pa., said they have received more calls from customers worried about possible default, but few are pulling out of the market.

“By and large they are seeking information, not making any significant moves,’’ said Fidelity spokesman Adam Banker.

Vanguard spokeswoman Linda Wolohan said, “We’re not seeing any flight from funds.’’

Both companies, however, have moved to calm their customers, e-mailing investors and posting information about the debt ceiling debate and its implications. Their general advice: Stay calm, don’t get caught up in short-term developments, and keep a long-term view in investing.

At another Boston mutual fund company, MFS Investment Management, bond managers and traders, who meet every weekday to discuss market developments, are debating whether to adjust their investments in anticipation of a possible downgrade of US credit or a default.

Fund managers have a range of options, such as moving money into cash and safe havens like gold; converting US bonds or cash into foreign bonds and currencies; or buying insurance against a US default through an instrument called a credit default swap.

Erik Weisman, an MFS portfolio manager, said it is hard to know what may be the right strategy. “There’s an awful lot of questions and not many answers,’’ he said.

Another Boston fund manager, Eaton Vance Corp., said it has increased its holdings in US treasuries in recent months, viewing the government bonds as a safer haven in the face of sluggish economy.

“I think a default is unlikely,’’ said Tom Luster, head of investment grade bond investments for Eaton Vance.

Banks do not believe a default is likely, either, but are taking precautions. Though they would not provide details of contingency plans, banking analysts said they are probably running through a range of scenarios to gauge the impact of a default on their financial investments, loans, and the broader economy.

They are also apt to be considering ways to help customers affected by a temporary suspension of Social Security and other federal payments, such as extending the deadline to make loan payments, waiving overdraft fees, or temporarily extending credit to customers.

“We’re not going to leave our customers high and dry,’’ said Eastern Bank spokesman Joe Bartolotta.

But Jaret Seiberg, an analyst with MF Global’s Washington Research Group in Washington, said it is difficult to plan because a default would have so many ripple effects, including the possibility of driving the economy into recession.

“It’s not the first order of facts,’’ Seiberg said. “It’s what happens if this spirals out of control. It’s very unclear what happens.’’

In the event of a default, Seiberg said, banking regulators probably would try to help banks get through the crisis, allowing them, for example, to continue counting US treasuries as safe investments.

David J. Cotney, Massachusetts’ commissioner of banks, , does not anticipate any community banks would run into trouble, because a government default would be very temporary. He also pointed out that Massachusetts banks have solid capital reserves and survived the recent financial and economic crisis.

“Hopefully, clearer heads will prevail and we can avoid this crisis,’’ Cotney said. “But even if we . . . hit the debt ceiling, and we don’t have a resolution in place, I’m sure the administration and Congress can come together very quickly to take care of this.’’

Todd Wallack can be reached at twallack@globe.com