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Wall Street seeks to soothe, while preparing for trouble

Susanne Craig and Jessica Silver-Greenberg
Adam Jeffery | CNBC

The government is partly shut down, but a bigger concern for financial executives is a potential default on public debt should Congress fail to raise the nation's borrowing limits. Financial companies are making some early preparations just in case.

The pivotal date is in less than two weeks. The Obama administration has said that on Oct. 17 it will no longer be able to finance government obligations without raising the $16.7 trillion cap on government borrowing. A Treasury Department report released on Thursday said the debt limit impasse could cause credit markets to freeze, the dollar to plunge and interest rates to rise. A default, the report added, could potentially result "in a financial crisis and recession that could echo the events of 2008 or worse."

A default would make it tough for the Treasury to make good on coming interest payments and other obligations, including paying scores of government employees and financing critical safety net programs like Social Security and Medicare.

Wall Street remains confident that a deal to avert a default will materialize, according to interviews with senior executives, who spoke on the condition of anonymity because of company policies against speaking to the media. The relatively upbeat sentiment grew on Thursday, stoked by reports that Speaker John A. Boehner had indicated to colleagues that he was determined to prevent a federal default.

And while Wall Street is sanguine, big banks like Morgan Stanley and Citigroup are still working out contingency plans that involve redoubling efforts to keep clients calm and are selling government bonds — a sign that confidence in Washington has waned.

To guard against possible mayhem from a debt ceiling crisis, some of the nation's largest banks are deploying plans that were developed in 2011 — when the government first looked as if it were on the verge of surpassing its debt ceiling limits.

One senior bank executive said his bank's plan includes stocking retail branches with at least 20 percent more cash. That way, any customers who want to stockpile cash reserves in the event of a default can readily withdraw their money.

The executive also said that his bank was adopting safeguards to protect customers whose income flows from Social Security or other government programs from incurring any fees. The executive said that the bank intended to waive all fees and possibly advance customers money interest-free if their government checks were delayed.

At Morgan Stanley, there was speculation last week that the troubles in Washington might derail a conference taking place at West Point on Thursday and Friday for traders at big asset managers. But the markets have been manageable so far, and the meeting proceeded, according to attendees.

On the wealth management side, the bank prepared this week a concise note for its team of financial advisers, many of whom are fielding calls from clients about both the debt ceiling and government shutdown. "We believe there is a zero percent chance of a federal government default at this time," the note said. "The U.S. government will pay its bills."

The report also noted that there had been 17 government shutdowns since 1976, a fact one adviser said he was emphasizing with clients this week. "I am not a soothsayer, but I'm more of a soothing sayer, someone who will remind them that this is going to be all right."

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The financial advisers noted that clients were keenly aware of the tax consequences they would face if they choose to leave the stock market hastily. Those who do, the advisers said, could incur a hefty tax bill.

Most brokers are not strangers to the anxiety surrounding the debt ceiling. Just two years ago, the nation faced the same looming prospect of a default, when the government needed to raise its cap on borrowing from $14.3 trillion.

"We have seen this movie before," said Steven Wieting, the global chief investment strategist at Citigroup's private bank. Just like in 2011, "this will be resolved," he said.

That is not to say that past Congressional skirmishes over the debt ceiling did not have an effect. In 2011, the fight prompted Standard & Poor's to lower the United States' credit rating, and the -stock index swooned more than 10 percent.

In a note to clients earlier this week, Mr. Wieting said: "Like seeing a horror movie a second time around, we see the markets 'recoiling' far less."

Beyond their preparations, some Wall Street executives have been discussing which hedge funds are poised to reap big gains in the event of a default. Bankers have been speculating about which hedge funds have quietly built bets on a default. That alone was one of the liveliest topics of conversation last week at an exclusive Wall Street meeting in Singapore.

One thing Wall Street executives seem to agree on is that the debate has hurt America's image, both at home and abroad.

"This is a really serious issue," said Laurence D. Fink , the chairman and chief executive of BlackRock, the world's largest asset manager. "It may not happen, but the fact the government has allowed this narrative is bad enough. We should be saying we are a principled nation and would never allow a default."