As lawmakers continue to debate what will be needed to raise the nation’s $31.4 trillion debt limit, the United States is teetering on the brink of bankruptcy.
That raised questions about what would happen if the U.S. defaulted on its debt default, as well as how key players were preparing for that scenario and what would happen if the Treasury Department defaulted. Creditors.
Such a situation is unprecedented, so it is difficult to say for sure how it will turn out. But investors and policymakers are asking, “What if?” It’s not the first time you’ve thought about it. And they’re busy updating their playbooks, thinking things can get done this time.
While negotiators are talking and seeming to be on their way to an agreement, time is short and There is no doubt that the debt ceiling will be lifted before June 1, the Treasury Department estimates that the government will run out of money to pay it all. Bills are due in time, known as the “X-date”.
Big questions remain, including what will happen in the markets, whether the government plans for a default and what will happen if the United States runs out of money. See how things can be.
Financial markets have become more volatile as the US approaches X-Day. This week, Fitch Ratings said it was downgrading the country’s top AAA credit rating. DBRS Morningstar, another rating firm, did the same on Thursday.
For now, the Treasury is still selling debt and making payments to creditors.
This has helped to ameliorate some concerns that the Treasury may not be able to fully repay the debt as opposed to interest payments. That’s because the government has a regular schedule of new Treasury auctions where it sells bonds to raise fresh cash. The auctions are scheduled as the Treasury borrows new money at the same time as it repays its old debts.
That would allow the Treasury to avoid adding too much to its $31.4 trillion debt burden. It needs money to avoid any disruption in payments, at least for the time being.
This week, for example, the government sold two-year, five-year and seven-year bonds. However, the debt will not be “fixed” – the cash will be sent to the Treasury and the guarantee to buyers at the auction until May 31, which coincides with three other guarantees coming up.
More precisely, the new money borrowed is slightly greater than the amount coming in. The Treasury borrowed $120 billion in three different notes this week. While nearly $150 billion of debt is due on May 31, $60 billion of that is held by the government from past market interventions, meaning it will end up paying itself off on this portion of the debt, with $30 billion remaining. cash, according to TD Securities analysts.
Some of that could amount to $12 billion in interest payments that the Treasury must pay that day. But as time goes on and the debt ceiling becomes more difficult to avoid, the Treasury will have to postpone any further fundraising, as it did during the 2015 debt ceiling debate.
After X-day, before default
The U.S. Treasury pays its debt through a federal payment system called Fedwire. Big banks hold accounts on Fedwire and the Treasury uses those accounts to make payments on its debt. These banks pass the payments through market pipelines and clearinghouses like the Fixed Income Clearing Corporation, where the money is ultimately transferred from domestic pensioners to holders’ accounts at foreign central banks.
The Treasury can try and stave off default by extending future debt maturities. Because of the way the FedWire is structured, in the unlikely event that the Treasury chooses to push the maturity of the debt, it would need to do so before 10 p.m. the day before the debt matures, according to contingency plans. It was developed by trade group the Securities Industry and Financial Markets Association, or SIFMA. The team expects that if this is done, the maturity will be extended by only one day.
Investors worry that if the government runs out of cash, it could miss interest payments on other debt. The first big test of that will come on June 15, when interest payments on notes and bonds with initial maturities of more than a year will be due.
Moody’s, the rating agency, said it was most concerned about June 15 as the date the government could default. However, it could be helped by corporate taxes coming into the coffers next month.
According to SIFMA, the Treasury cannot delay interest payments without default, but it can notify the Fedwire as early as 7:30 a.m. that the payment will not be ready that morning. He then has until 4:30pm to make the payment and avoid the default.
If a default is feared, SIFMA — along with representatives from Fedwire, banks and other industry players — plans to make up to two calls the day before a default occurs and three more on the day the payment is due. Following the same script with each call to update, review and plan for potential.
“I think we have a pretty good idea of what’s going to happen in terms of settlements, infrastructure and pipelines,” said Rob Toomey, head of capital markets at SIFMA. “It’s about what we can do. As for the long-term consequences, we don’t know. What we’re trying to do is minimize disruption when a disruptive situation occurs.
default and beyond
A big question is how the United States will determine whether it can actually default on its debt.
There are two main ways in which the Treasury can decline. Loss of interest payment on the debt or without full payment of the borrowed money.
That led to speculation that the Treasury Department could prioritize payments to bondholders ahead of other bills. If bond funds are repaid but others are not, ratings agencies may determine that the United States has defaulted.
But Treasury Secretary Janet L. Yellen pointed out that any unpaid payments would essentially be considered a default.
Shai Akabas, director of economic policy at the Bipartisan Policy Center, said an early warning sign that a default is coming could come from a failed Treasury bid. The Treasury Department closely monitors spending and income tax revenue, anticipating potential missed payments.
At the time, Mr. Akabas said that Ms. Yellen could issue a warning when she predicts that the United States will not be able to pay all the payments on time, and she will communicate her intended contingency plan. to follow.
Investors, as well as industry groups that monitor the Treasury’s key deadline to notify the Fed that it will not make a scheduled payment, will receive updates.
A default then raises potential problems.
Ratings firms have said a missed payment would result in a downgrade of the U.S. debt — and Moody’s has said it won’t restore the AAA rating until the debt ceiling is subject to a political meltdown.
World leaders have questioned whether the United States should continue to endure repeated debt ceiling crises, given its central role in the global economy. Central bankers, politicians and economists have warned that a default could push America into recession, with second-order effects from corporate bankruptcies to rising unemployment.
But these are just a few of the dangers that are known to lurk.
“It’s all raw water,” Mr. Akabas said. “There’s no playbook to go by.”