How a pattern can unfold

How a pattern can unfold

The United States is edging closer to calamity as lawmakers continue to wrangle over what it will take to raise the country’s $31.4 trillion debt limit.

This raised questions about what would happen if the United States did not raise its borrowing limit in time to avoid defaulting on its debt, along with how major players are preparing for this scenario and what would actually happen if the Department of the Treasury did not pay its debts. creditors.

Such a situation would be unprecedented, so it’s hard to say with certainty what it would look like. But it’s not the first time investors and policymakers have had to contemplate “what if?” and they’re busy updating their playbooks on how they think things might go this time around.

While negotiators talk and appear to be moving towards an agreement, time is short and there is no certainty that the debt limit will be lifted before June 1, the earliest the Treasury estimates the government will run out of money to pay all debts. your debts. up-to-date accounts, known as “X-date”.

Big questions remain, including what could happen in the markets, how the government is planning to default and what will happen if the US runs out of cash. Here’s a look at how things could play out.

Financial markets grew more jittery as the United States approached date X. This week, Fitch Ratings said it was putting the nation’s top AAA credit rating on review for possible downgrade. DBRS Morningstar, another ratings company, did the same on Thursday.

For now, the Treasury is still selling debt and making payments to its creditors.

That helped assuage some concerns that the Treasury won’t be able to repay the overdue debt in full, rather than just an interest payment. That’s because the government has a regular schedule of new Treasury auctions, where it sells bonds to raise new money. The auctions are timed so that the Treasury borrows new money at the same time that it pays off its old debts.

That allows the Treasury to avoid adding too much to its $31.4 trillion outstanding debt — something it can’t do now, as it enacted extraordinary measures after coming close to the debt limit on Jan. 19. money needed to avoid any interruption in payments, at least for the time being.

This week, for example, the government sold bonds of two, five and seven years. However, this debt is not “liquidated” – that is, the money is delivered to the Treasury and the bonds delivered to buyers at the auction – until May 31, coinciding with the maturity of three other bonds.

More precisely, the new borrowed money is slightly more than the amount that is coming due. The Treasury borrowed $120 billion this week in three different bills. While around $150 billion in debt is due on May 31, around $60 billion is held by the government due to past crisis interventions in the market, meaning it ends up paying itself on that portion of the debt, leaving US $30 billion in extra debt. cash, according to analysts at TD Securities.

Part of that could go towards the $12 billion in interest payments the Treasury is also expected to pay that day. But as time passes and the debt limit becomes more difficult to avoid, the Treasury may have to delay any incremental fundraising, as it did during the 2015 debt limit impasse.

The US Treasury pays its debts through a federal payments system called Fedwire. The big banks maintain accounts at Fedwire, and the Treasury credits these accounts with payments on its debt. These banks then pass payments down the market pipeline and through clearinghouses such as the Fixed Income Clearing Corporation, with the money eventually ending up in the accounts of holders, from domestic retirees to foreign central banks.

The Treasury could try to delay default by extending the maturity of maturing debt. Due to the way Fedwire is set up, in the unlikely event that the Treasury decides to delay the maturity of its debt, it would need to do so no later than 10:00 pm on the day before the debt is due, as per the contingency plans . established by the Securities Industry and Financial Markets Association trade group, or SIFMA. The group’s expectation is that, if this is done, the expiration date will be extended by only one day at a time.

Investors are more nervous about the possibility that, if the government runs out of cash on hand, it could miss interest payments on its other debt. The first big test of this will come on June 15, when interest payments on notes and bonds with original maturities of more than one year are due.

Moody’s, the ratings agency, said it is most concerned about June 15 as the possible day the government could default. However, it might be helped by corporate taxes flowing into their coffers next month.

Treasury cannot delay interest payments without default, according to SIFMA, but it can notify Fedwire by 7:30 am that the payment will not be ready for the morning. He would then have until 4:30 pm to make the payment and avoid default.

If there is a fear of default, SIFMA – along with representatives from Fedwire, the banks and other industry players – plans to call up to two calls the day before a default occurs and three more calls the day the payment is due. due. with each call following a similar roadmap to update, assess and plan for what could happen.

“On settlement, infrastructure and plumbing, I think we have a pretty good idea of ​​what could happen,” said Rob Toomey, head of capital markets at SIFMA. “It’s the best we can do. When it comes to the long-term consequences, we don’t know. What we are trying to do is minimize disruption in what will be a disruptive situation.”

A big question is how the United States will determine whether it has actually defaulted on its debt.

There are two main ways of Treasury defaults; fail to pay interest on your debt or fail to pay your loans when the full amount is due.

That sparked speculation that the Treasury Department might prioritize payments to bondholders over other bills. If bondholders are paid but others are not, the ratings agencies are likely to rule that the United States has dodged default.

But Treasury Secretary Janet L. Yellen has suggested that any default will essentially result in default.

Shai Akabas, director of economic policy at the Bipartisan Policy Center, said a warning sign that a default is coming could come in the form of a failed Treasury auction. The Treasury Department will also closely monitor your incoming tax expenditures and income to anticipate when a payment delay may occur.

At that point, Akabas said, Yellen is likely to issue a notice with the specific timing of when she anticipates the United States will not be able to make all of its payments on time and announce the contingency plans she envisions. to chase.

For investors, they will also receive updates through industry groups tracking key deadlines for the Treasury to notify Fedwire that it will not make a scheduled payment.

A default would trigger a cascade of potential problems.

The ratings companies have said that a missed payment would warrant a downgrade on the US debt – and Moody’s has said it will not restore the AAA rating until the debt ceiling is no longer subject to political provocation.

International leaders have questioned whether the world should continue to tolerate repeated debt ceiling crises, given the integral role the United States plays in the global economy. Central bankers, politicians and economists have warned that a default is likely to tip the United States into a recession, leading to waves of second-round effects from corporate bankruptcies to rising unemployment.

But those are just a few of the risks known to lurk.

“All of these are uncharted waters,” Akabas said. “There is no manual to follow.”


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