Servicing the debt
Investment managers, the finance industry and the Fed have contingencies for the debt ceiling drama.
Against the backdrop of the uncertainty of the past year and a half, one thing remains predictable: the political theater of Washington. As we head into the final days of September, we once again face the potential of a government shutdown. Worse yet, politicians are flirting with the sanctity of the “full faith and credit” of the U.S.
Peppered with headlines suggesting a default on federal debt, many investors are understandably concerned, but the probability of the government actually failing to make good on its obligations is extremely low. That said, should the unthinkable happen, the U.S. Treasury, Federal Reserve and securities market participants have contingency plans to mitigate the market impact that even a delay in payment might bring.
After a two-year suspension, the limit on Federal debt outstanding was reinstated on Aug. 1. This forced Treasury to issue fewer securities, cutting back Treasury bill issuance to preserve auction sizes of longer-term securities. It also now relies on its existing cash balance, the use of “extraordinary measures” and prioritizing its financial obligations. Here is the maddening part: though Congress has already approved the spending taking place since the beginning of August, the actual act of raising the debt ceiling requires separate action.
The impasse exists because most Republicans don’t want to go on record as having voted for an increase. Democrats likely will have to pass it through reconciliation that requires only a majority vote. But this will take time, which the Treasury also has in low supply. As the pandemic has made cash flows less certain than usual, no one is really sure when the U.S. will run out completely, but most estimates range from mid-October to mid-November, with a nod to early in November. [Editor's note: On Sept. 28, Treasury Secretary Yellen told Congress the Treasury could run out of options around Oct. 18].
But this time, the markets and others financial institutions are ready. The Securities Industry and Financial Markets Association (Sifma) and the Treasury Markets Practices Group (a private sector group sponsored by the New York Fed) have recently affirmed contingency plans to facilitate the trading, clearing and settlement of Treasury securities if faced with a technical default. The New York Fed also stands as an important backstop for money market funds as an investment (Reverse Repo Facility, or RRP) and for dealers and banks to borrow from (the recently announced Fed Standing Repo Facility). It is believed that Treasury can prioritize payments on debt obligations over others. Finally, it is thought the Fed would have the ability to take certain emergency actions to facilitate the trading of Treasuries should a default occur.
Government money market funds hold robust liquidity even in normal times and as the debt ceiling showdown intensifies, our liquidity management team, like others in the industry, could take actions to boost liquidity levels, including by increasing usage of the RRP, and hold outright cash positions. We are confident we will navigate through this unnecessarily uncertain period until an agreement is reached.