Technical or not, debt-limit default could spell Treasuries nightmare


Nobody doubts that the United States will make good on its debts.

However if Congress fails to lift the debt ceiling in time, what is called a “technical” default — one which only delays interest and principal payments — are on deck for the {}14.1-trillion (U.S.) Treasury market, introducing a potentially devastating variety of complications.

Bond-market industry groups are not waiting to see how it plays out. They are fine-tuning prior blueprints for how to manage affected securities so trading is uninterrupted and the plumbing of a vital market for short-term funding still works. However, nailing down the back-office preparations does not alleviate concern that investors may shun Treasuries amid the upheaval.

Samp;P Global Ratings cut the U.S.’s top score amid the 2011 debt-limit standoff and cautioned last week that failure to raise the debt ceiling will likely be more detrimental to the economy than the collapse of Lehman Brothers Holdings Inc..

  • Mnuchin’s promise: Treasury Secretary Steven Mnuchin reiterated last week that it is essential to elevate his borrowing authority by Sept. 29, also said he is convinced law makers will do so in time. The prospect of a bargain might become entangled with attempts to tackle relief aid for Hurricane Harvey. “The President and I believe that it needs to be tied into the Harvey funding,” Mr. Mnuchin said of this debt-cap growth on Fox News Sunday.

House Speaker Paul Ryan told the Milwaukee Journal Sentinel on Sept. 1 that Congress has until October to behave on the debt ceiling, and also said the nation won’t default.

Investors have been down this road before, but a technical default would raise the showdown to a different degree, with ripple effects in these areas.

  • Treasury auctions: Past Treasury secretaries, pushed to the limit of the extraordinary measures they could tap to remain under the debt limit, have resorted to postponing debt earnings. This year, analysts say two-, five- and – seven-year note earnings in late September are in danger.

In 2015, then-secretary Jacob Lew postponed a two-year auction. In 1996, Robert Rubin postponed sales of 2- and five-year notes, in addition to a one-year bill.

  • Repo fix: The Securities Industry and Financial Markets Association and the Treasury Market Practices Group have done lots of work to prepare for previous debt-ceiling episodes. They are dusting off those plans today, laying the groundwork for processing debt with payments that are delayed. That would permit the securities to be cleared from the {}1.8-trillion marketplace for tri-party repurchase agreements.

Nevertheless, lenders will probably see this collateral as riskier, causing them to provide less money in Retailer prices backed by the securities and tripping margin calls, according to JPMorgan Chase amp; Co.. That scenario could risk worsening Treasury-market liquidity ruined by investor unease surrounding any default.

  • Lending prices: Rates on Treasury bills due around the X-date have risen as investors shun the debt. In the case of an actual technical default, yields even longer maturities could increase as well, ultimately raising the government’s financing costs.

The extra tab to U.S. taxpayers from higher yields in the 2013 debt-cap episode reached up to $70-million, while at the 2011 episode, which caused a U.S. downgrade, prices rose by $1.3-billion, according to the U.S. Government Accountability Office.

  • Money-fund socket: There’s one post-financial-crisis change that might help limit the fallout. It is that cash funds — key buyers of Treasury bills — have a fresh choice for parking their money, in the kind of the Fed’s overnight reverse repo agreements. The RRPs, as they are known, will provide funds seeking to prevent government debt a safe alternative with virtually unlimited accessibility.

First introduced in September, 2013, these prices were not really a viable option during the prior debt-limit showdown. That is because few funds could take part and the Fed capped firms’ usage at $1-billion per day. Now, there is a $30-billion limitation for every entity and 136 counterparties, 102 of which are money-market mutual funds.

Even with all the progress preparations, a technical default nevertheless dangers with a dire and lasting effect. This was the takeaway for observers back in 2013.

Courtesy: The Globe And Mail

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