How a standard can unfold

The United States moves ever closer to disaster as lawmakers continue to debate what it takes to raise the country’s $31.4 trillion debt limit.

That has raised questions about what would happen if the United States doesn’t raise its lending ceiling in time to avoid paying off its debt, along with how key players are preparing for that scenario and what would actually happen if the Treasury Department would fail to repay its debts. lenders.

Such a situation would be unprecedented, so it’s hard to say for sure how it will turn out. But it’s not the first time investors and policymakers have had to ask themselves “what if?” and they’ve been busy updating their playbooks for how they think things might play out this time.

While negotiators talk and appear to be moving toward a deal, time is short and there is no certainty that the debt limit will be lifted before June 1, the earliest date the Treasury estimates the government will run out of money to pay all to pay her debts. bills on time, known as the “X date”.

Big questions remain, including what might happen in the markets, how the government plans to default, and what happens when the United States runs out of money. Here’s a look at how things could unfold.

For the X Date

Financial markets have become more nervous as the United States moves closer to the X date. This week, Fitch Ratings said it would put the country’s top AAA credit rating up for review for a possible degradation. DBRS Morningstar, another rating agency, did the same on Thursday.

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

That has allayed some concerns that the Treasury will not be able to repay the debt that has fallen due in full, as opposed to 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 scheduled so that the Treasury receives its new borrowed cash the moment it pays off its old debts.

That allows the Treasury to avoid adding much to its outstanding debt of $31.4 trillion — something it can’t do now because it took extraordinary action after falling within a whisker of the debt limit on Jan. 19. come. And it would give the Treasury the cash it needs to avoid defaults, at least for now.

For example, the government sold two-year, five-year and seven-year bonds this week. However, that debt isn’t “settled” until May 31 — meaning the money is delivered to the Treasury and the securities are delivered to the buyers — which coincides with three other securities falling due.

More precisely, the new money borrowed slightly exceeds the amount owed. The Treasury borrowed $120 billion across the three different notes this week. While about $150 billion of debt is due May 31, about $60 billion of this is held by the government from previous crisis interventions in the market, meaning it will eventually pay for itself on this portion of the debt, leaving $30 billion in extra cash left over, according to TD Securities analysts.

Part of that could go toward the $12 billion in interest payments the Treasury is also due that day. But as time passes and the debt limit becomes harder to avoid, the Treasury may have to postpone any incremental fundraising, as it did during the 2015 debt limit deadlock.

After the X date, before default

The US Treasury Department pays its debts through a federal payment system called Fedwire. Major banks have accounts with Fedwire, and the Treasury credits those accounts with payments on its debt. These banks then route the payments through the conduits of the market and through clearinghouses, such as the Fixed Income Clearing Corporation, with the money eventually ending up in the accounts of domestic retiree holders to foreign central banks.

The Treasury could try to avert bankruptcy by extending the term of the debt due. Because of the way Fedwire is set up, in the unlikely event that the Treasury elects to extend the maturity of its debt, contingency plans would require the Treasury to do so no later than 10 p.m. the day before the debt matures. prepared by the Securities Industry and Financial Markets Association trading group, or SIFMA. The group expects that if this happens, the term will only be extended by one day at a time.

Investors are nervous that if the government used up its available cash, it could miss an interest payment on its other debt. The first major test of this comes on June 15, when interest payments on banknotes and bonds with original maturities of more than a year become due.

Moody’s, the rating agency, has said it is most concerned about June 15 as the possible day the government could default. However, it may be helped by the corporate tax that flows into the Treasury next month.

The Treasury can’t delay an interest payment without defaulting, according to SIFMA, but it could tell Fedwire at 7:30 a.m. that the payment won’t be ready by tomorrow morning. It would then have until 4:30 p.m. to make the payment and avoid default.

If a default is feared, SIFMA – along with representatives from Fedwire, the banks and other industry players – plans to make up to two calls the day before a default can occur and three additional calls the day a payment is due. with each conversation following a similar script to update, review and plan for what might unfold.

“In terms of settlement, infrastructure and sanitation, I think we have a good sense of what could happen,” said Rob Toomey, head of capital markets at SIFMA. “It’s about doing the best we can. As for the long-term consequences, we don’t know. What we are trying to do is minimize disruption in what will be a disruptive situation.”

Standard and beyond

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

There are two main ways the Treasury can default; missing an interest payment on his debt, or failing to repay his loans when the full amount falls due.

That has led to speculation that the Treasury Department could prioritize payments to bondholders over other bills. If bondholders are paid but others are not, credit rating agencies are likely to judge that the United States has evaded bankruptcy.

But Treasury Secretary Janet L. Yellen has suggested that any missed payment essentially amounts to a default.

Shai Akabas, director of economic policy at the Bipartisan Policy Center, said an early warning sign that a default was imminent could come in the form of a botched Treasury bill auction. The Treasury Department will also closely monitor spending and incoming tax revenue to predict in advance when a missed payment might occur.

At that point, Mr Akabas said, it is likely that Ms Yellen will issue a warning with the specific timing of when she predicts the United States will not be able to make all its payments on time and announce the contingency plans which she plans. pursue.

Investors will also receive updates through industry groups tracking key deadlines for the Treasury to inform Fedwire that it will not make a scheduled payment.

A default would then trigger a cascade of potential problems.

Rating agencies have said a missed payment would warrant a reduction in US debt – and Moody’s has said it will not reinstate the AAA rating until the debt ceiling is no longer subject to political constraints.

International leaders have questioned whether the world should continue to tolerate repeated debt crises given the integral role the United States plays in the global economy. Central bankers, politicians and economists have warned that bankruptcy is likely to send America into recession, triggering waves of secondary effects, from corporate failures to rising unemployment.

But those are just some of the risks known to lurk.

“This is all uncharted territory,” Mr Akabas said. “There’s no script to go by.”