Securities Markets Make Contingency Plans in Case of U.S. Default on Debt
By K. Claire Compton
Financial markets are preparing for the worst as Capitol Hill remains unable and unwilling to forge a debt limit deal, threatening a first-ever U.S. default.
The Securities Industry and Financial Markets Association (SIFMA) said Oct. 4 that their members have planned, in the case the debt limit is breached, a series of conference calls for the day before a scheduled Treasury security reaches maturity, which could go unpaid.
Rob Toomey, managing director and associate general counsel at SIFMA, told reporters on a call that the organization’s membership is paying close attention to the security schedule and said that the knock-on effect of a default would affect the entire financial system.
Treasury believes it will exhaust its extraordinary measures by Oct. 17, at which point it will have only cash balances to pay the government’s obligations. A Treasury bill worth $120 billion is scheduled to mature on Oct. 17, and a $93 billion bill is scheduled to mature Oct. 24. The Treasury is also expected to make principal and interest payments on several bills and notes on Oct. 31.
Financial markets expect that in the case of a default, the Treasury would extend maturities on a day-to-day basis. But the timing of Treasury announcements as to whether it will be able to make a scheduled payment is key for stakeholders with processes that begin the evening before a maturity date.
The Federal Reserve’s Fedwire, the service that transfers Treasury securities, begins settlement processes at about 7 p.m., and other clearing banks begin their processes shortly after. Toomey said those could be delayed until 10 p.m., but beyond that a missed payment could result in lost liquidity.
No Faith or Credit
“What happens to the security is it disappears. In the sense that it cannot be transferred once it becomes due the following day, it cannot be sold, it cannot be financed, it cannot be used as collateral,” Toomey said. “It probably can’t be used at the Fed’s finance window. Essentially, whatever amount that security is will disappear from the market at the time of nonpayment.”
The disruption of even a single Treasury security payment would have even worse effects on the market as a whole, Toomey added, as investors lose faith in the ability of Treasury to repay short-term securities. As the benchmark by which other types of credit are priced in the U.S. economy, a rise in Treasury security rates would push up rates for mortgages and commercial loans.
“For clearinghouses around the world, the collateral choice is U.S. treasuries. Whether or not they continue to accept that, well the expectations are that they won’t be good collateral, so the knock-on consequences are significant there.”
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The SIFMA fact sheet on Treasury market operations can be found here: http://www.sifma.org/newsroom/2013/sifma-statement-and-fact-sheets-on-the-debt-default-threat/.