Wall Street firms are sounding alarm bells and dusting off contingency plans as fears grow that Congress may fail to reach a deal to raise the country’s debt limit in time, executives said.
With federal government funding due to expire on Thursday, September 30, and borrowing authority set to run out on October 18, Democrats who narrowly control both chambers of Congress are scrambling to prevent an unprecedented US credit default. Their latest efforts on Tuesday, September 28, were blocked by Republicans.
A failure to raise the legal cap on how much money the government can borrow to fund its budget deficits and meet debt obligations, currently set at $28.4 trillion, could send shockwaves across global markets.
“If there were to be some kind of failure to pay Treasury securities, we honestly don’t know what would happen,” said Rob Toomey, managing director and associate general counsel for capital markets at the Securities Industry and Financial Markets Association (SIFMA).
“Certainly, you can expect significant volatility were this to occur, and the market needs to be prepared for that.”
JPMorgan Chase & Co. chief executive officer Jamie Dimon told Reuters on Tuesday that the bank had begun preparing for the possibility of a US default, a “potentially catastrophic” event, although he added he expected lawmakers would reach a last-minute deal.
Some analysts say, though, that the uncertainty is showing slightly in the spread between one-month Treasury bills and three-month Treasury bills, which are perceived to carry less risk of default. One-month bills currently yield 0.07% compared to 0.04% for three-month bills. At the beginning of the year, both yielded around 0.08%.
Previous debt limit crises have roiled global markets, despite being resolved. A now-notorious 2011 standoff over the ceiling led S&P Global Ratings to downgrade US sovereign debt for the first time, wiping $2.4 trillion off US stocks. Talks went to the wire again in 2017, although with less disruption.
Investment bank Goldman Sachs this month described the standoff as “the riskiest debt-limit deadline in a decade.”
Eric Pan, CEO of the Investment Company Institute (ICI), a trade group representing the world’s largest fund managers, said his members were concerned about the financial ramifications of a possible US default for savers globally.
“ICI has made it clear in our conversations with Capitol Hill that failing to raise the debt limit would not only hurt our capital markets, it would negatively impact their constituents, regardless of income or political affiliation,” he added.
Given how badly exposed Wall Street banks, dealers, and investors would be to a default, they have to prepare for the possibility even if they expect the crisis to be resolved.
“We’ve been through this a number of times,” said Toomey, adding the group had reprised its previous plans for a scenario in which the Treasury is unable to pay off debt coming due.
“We’ve been dusting off that kind of work with our members to make sure that everybody is on the same page.”
SIFMA is working on two scenarios. The more likely would see the Treasury buy time to pay back bondholders by announcing ahead of a payment that it would be rolling those maturing securities over for another day. That would allow the market to continue functioning even if there was broader volatility.
The other, much less likely scenario would see the Treasury allow bonds to mature, which would be more disruptive as the unpaid bonds would still need to be settled but would no longer exist in the US Federal Reserve’s systems, said SIFMA.
In general, these plans aim to ensure firms have enough technology capacity, staff, and cash to handle high trading volumes to ensure the markets continue to function.
The Treasury Market Practices Group, a group of bond dealers convened by the New York Fed, also has a plan for trading in defaulted Treasuries, which it reviewed earlier this year.
Internally, individual banks are also making plans.
Dimon said JPMorgan had begun scenario-planning for how a default would affect the repo and money markets, its capital ratios, and how ratings agencies would react. The bank has also begun combing through its client contracts to understand how they will react.
“You’ve got to check the contracts to try to predict it out,” he said. “It’s a lot of work.” – Rappler.com