Credit Suisse Prediction: With US Default, Stocks Drop 30%, Economy Contracts 5%

(July 28, 2011) — A new paper by Credit Suisse predicts that in the unlikely event that the United States defaults on its debt obligations, stocks would drop 30% and gross domestic product would fall 5%.

Furthermore, the report asserts that worries about public finances in the United States will likely bring investors to focus increasingly on ultra-safe equities.

The chance of a rating downgrade on US sovereign debt could happen even if the debt ceiling is raised, the report said. Yet, expressing confidence that a ratings downgrade would not lead to disaster, the firm wrote in its paper: “We think there is a 50% chance of a ratings downgrade on US sovereign debt. This could happen even if the debt ceiling is raised. We doubt it will have much effect.”

Additionally, the report predicted that if no budget deal is struck, but the US fails to default, stocks and the economy will experience difficulties. “It is almost unthinkable to believe that the US would miss a coupon payment ($29 billion is due on August 15th),” the report stated. “If the US does default, there are massive ramifications. According to Credit Suisse chief economist Neal Soss, the repo market would probably cease to work. It is hard to imagine money market funds operating under this scenario. The inter-bank market would freeze up. The fallout would be far worse than after the Lehman’s default. Back then, the US government could at least spend and do the ‘right thing’, while now the only back-stop would be the Fed.”

Rating agency Moody’s recently suggested complete elimination of the debt ceiling. “We would reduce our assessment of event risk if the government changed its framework for managing government debt to lessen or eliminate that uncertainty,” Moody’s analyst Steven Hess wrote in a report.

Last week, the rating agency cautioned that it would slash the US’ AAA credit rating if the government misses debt payments. It noted that because lawmakers have acted to increase the debt ceiling, it had not previously considered the situation high-risk.