By Davide Barbuscia and Pete Schroeder
NEW YORK/WASHINGTON (Reuters) – As talks on raising the U.S. government debt ceiling to $31.4 trillion culminate, Wall Street banks and asset managers brace for fallout from a default potential.
The financial industry has prepared for such a crisis before, most recently in September 2021. But this time the relatively short time to reach a compromise worries bankers, a senior industry official said.
There are less than two weeks until June 1, when the Treasury Department has warned that the federal government may not be able to pay all of its debts, US Treasury Secretary Janet Yellen reiterated on Sunday.
Citigroup CEO Jane Fraser said this debt ceiling debate is “more worrying” than previous ones. JPMorgan Chase & CO CEO Jamie Dimon said the bank is calling weekly meetings on the implications.
WHAT HAPPENS IN THE EVENT OF US DEFAULT?
U.S. government bonds underpin the global financial system, so it’s difficult to fully assess the damage a default would create, but executives expect massive volatility in equity, debt and stock markets. other markets.
The ability to trade Treasury positions in the secondary market would be severely impaired.
Wall Street executives who have advised Treasury debt operations have warned that the dysfunctional Treasury market will quickly spread to derivatives, mortgage and commodity markets as investors question the validity of Treasuries. widely used as collateral to secure transactions and loans. Financial institutions could ask counterparties to replace bonds affected by missed payments, analysts said.
Even a short breach of the debt limit could lead to skyrocketing interest rates, falling stock prices, and breaches of covenants in loan documentation and leverage agreements.
Short-term funding markets would also likely crash, Moody’s Analytics said.
HOW ARE INSTITUTIONS PREPARING?
Banks, brokers and trading platforms are bracing for disruption in the Treasury market, as well as broader volatility.
This typically includes game planning on how payments on Treasury securities would be handled; how critical funding markets would react; ensuring sufficient technology, staffing capacity and liquidity to handle high transaction volumes; and check the potential impact on customer contracts.
Big bond investors warned that maintaining high levels of liquidity was important to weather potential wild swings in asset prices and to avoid having to sell at the worst possible time.
Bond trading platform Tradeweb said it was in discussions with clients, industry groups and other market participants about contingency plans.
WHAT SCENARIOS ARE ENVISAGED?
The Securities Industry and Financial Markets Association (SIFMA), a leading industry group, has a playbook detailing how stakeholders in the Treasury market – the Federal Reserve Bank of New York, the Fixed Income Clearing Corporation (FICC), clearing banks and treasury bill brokers – communicate before and during days of potential missed cash payments.
SIFMA considered several scenarios. Most likely, the Treasury would buy time to repay bondholders by announcing before a payment that it would roll over these maturing securities, extending them one day at a time.
This would allow the market to continue to operate, but interest would likely not accrue for the late payment.
In the most disruptive scenario, the Treasury pays neither principal nor coupon and does not extend maturities. Outstanding bonds could no longer be traded and would no longer be transferable on the Fedwire Securities Service, which is used to hold, transfer and settle treasury bills.
Each scenario would likely cause significant operational issues and require daily manual adjustments in the trading and settlement processes.
“It’s difficult because it’s unprecedented, but all we’re trying to do is make sure we develop a plan with our members to get them through what would be a disruptive situation,” he said. said Rob Toomey, Managing Director and Associate General Counsel of SIFMA. for capital markets.
The Treasury Market Practices Group — an industry group sponsored by the Federal Reserve of New York — also has a plan for trading unpaid Treasuries, which it reviewed in late 2022, according to meeting minutes on its website. dated November 29. The York Fed declined to comment further.
Moreover, during previous debt ceiling stalemates – in 2011 and 2013 – Fed staff and policymakers crafted a playbook that would likely provide a starting point, with the final and most sensitive step being to completely remove defaulted securities from the market.
The Depository Trust & Clearing Corporation, which owns FICC, said it was monitoring the situation and had modeled a variety of scenarios based on the SIFMA playbook.
“We are also working with our industry partners, regulators and participants to ensure activities are coordinated,” he said.
(Reporting by Davide Barbuscia; Editing by Megan Davies, Michelle Price and David Gregorio)