The United States is closing in on disaster, as lawmakers continue to scramble about what it will take to raise the country’s $31.4 trillion debt limit.
That raised questions about what would happen if the US did not raise the borrowing cap in time to avoid defaulting on its debt, along with how the major players are preparing for this scenario and what would actually happen if the Treasury failed to pay its debts. lenders.
Such a situation would be unprecedented, so it is difficult to say for sure how it will end. But it’s not the first time that investors and policymakers have had to think “what if?” And they’ve been busy updating their plans to see how they think things might work out this time.
While negotiators appear to be moving toward an agreement, time is short. There is no certainty that the debt limit will be raised before June 5, when the Treasury Department now estimates the government will run out of cash to pay all its bills on time, a moment known as the “X date.”
“We have to be in closing hours because of the schedule,” said Rep. Patrick McHenry, R-North Carolina, involved in the talks. “I don’t know if it’s the next day, two days, or the third, but it has to come together.”
Big questions remain, including what might happen in the markets, how the government plans to default and what would happen if the US ran out of cash. Here’s a look at how things developed.
before the date of X
Financial markets are becoming more nervous as the United States approaches the tenth date. While exuberance around earnings-boosting expectations for AI has helped the stock market recover, concerns about the debt limit remain. On Friday, the Standard & Poor’s 500 rose 1.3 percent, a modest gain of 0.3 percent for the week.
This week, Fitch Ratings said it was putting the country’s top AAA credit rating under review for a possible downgrade. DBRS Morningstar, another ratings firm, did the same on Thursday.
For now, the Treasury is still selling debt and making payments to its lenders.
This helped assuage some concerns that the Treasury would not be able to pay outstanding debt in full, rather than simply paying interest. That’s because the government has a regular schedule of new Treasury auctions where it sells bonds to raise new cash. The auctions are scheduled in such a way that the Treasury receives its new borrowed cash at the same time it pays off its old debts.
That allows the Treasury to avoid adding too much to its $31.4 trillion outstanding debt burden — something it cannot do now since it took extraordinary measures after it approached the debt limit on January 19. The cash you need to avoid any interruption in payments, at least for now.
This week, for example, the government sold two-, five- and seven-year bonds. However, this debt is not settled—meaning cash delivered to the Treasury and securities delivered to buyers at auction—until May 31, coinciding with the maturity of three other securities.
More precisely, the new cash being borrowed is slightly greater than the amount owed, with the difficult work of balancing all the money in and out indicating the challenge for the Treasury in the days and weeks ahead.
When all payments are recorded, the government ends up with just over $20 billion in additional cash, according to TD Securities.
Some of that could go to the $12 billion in interest payments the Treasury has to make that day. But as time goes on, and avoiding a debt limit becomes more difficult, the Treasury may have to delay any additional fundraising, as it did during a debt limit showdown in 2015.
After date X, before default
The US Treasury pays its debts through a federal payments system called Fedwire. Large banks maintain accounts at Fedwire, and the Treasury adds those accounts with their debt payments. These banks then pass the payments through the market’s plumbing and through clearing houses, such as the Fixed Income Clearing Corporation, with the cash eventually reaching the local retirees’ accounts to foreign central banks.
The Treasury could try to pay a default by extending the maturity of outstanding debt. Because of the way Fedwire is set up, in the unlikely event that the Treasury Department chooses to defer the maturity of its debt, it will need to do so by 10 p.m. at the latest on the day before the debt is due, according to contingency plans put out by the securities industry group and the Markets Association. Finance, or SIFMA. The Group expects that if this is done, the maturity will only be extended by one day at a time.
Investors are more nervous that if the government exhausts its available funds, it could miss paying interest on its other debts. The first big test of that will come on June 15, when interest payments on notes and bonds with an original maturity of more than a year are due.
Ratings agency Moody’s said it was very concerned about June 15 as the potential day the government might default. However, corporate taxes flowing into their coffers next month may help them.
The Treasury Department cannot delay an interest payment without default, according to SIFMA, but it can notify Fedwire by 7:30 a.m. that the payment will not be ready for the morning. She will then have until 4:30pm to make the payment and avoid default.
If a default is apprehended, SIFMA—along with representatives from Fedwire, banks, and other industry players—has plans to hold a maximum of two calls the day before the default occurs and three more calls the day the payment is due, with Each call follows a similar script of updating, evaluating, and planning what might unfold.
“In terms of settlement, infrastructure and plumbing, I think we have a pretty good idea of what could happen,” said Rob Twomey, SIFMA’s head of capital markets. “It’s about what we can do best. When it comes to the long-term consequences, we don’t know. What we’re trying to do is minimize disruption in what would be a disruptive situation.”
default and beyond
One of the big questions is how the US will determine whether it has indeed defaulted on its debt.
There are two main ways the Treasury can default: by not paying interest on its debts, or by not paying its loans when the full amount becomes due.
That sparked speculation that the Treasury Department could prioritize payments to bondholders over other bonds. If bondholders are paid but others are not, the rating agencies are likely to rule that the US has evaded default.
But Treasury Secretary Janet L. Yellen indicated that any missed payments would amount to a default.
An early warning sign that a default is coming could come in the form of a failed Treasury auction, said Shai Akabas, director of economic policy at the Bipartisan Policy Center. The Treasury will also closely track its expenditures and incoming tax revenue to predict when a payment will not be made.
At this point, Mr. Akabas said, Ms. Yellen is likely to issue a timing warning when she predicts the United States will not be able to make all of her payments on time and announce the contingency plans she intends to pursue.
For investors, they will also receive updates through industry groups that track key deadlines for the Treasury Department to notify Fedwire that it will not make the specified payment.
A default then sets off a chain of potential problems.
The ratings firms said the missed payment would be due for a US debt downgrade — and Moody’s said it would not restore its Aaa rating until the debt ceiling was no longer subject to political brinkmanship.
International leaders have questioned whether the world should continue to endure recurring debt ceiling crises given the fundamental role the United States plays in the global economy. Central bankers, politicians and economists have warned that a default will likely tip America into a recession, triggering waves of second-order effects from corporate bankruptcies to soaring unemployment.
But these are just some of the risks that are known to lurk.
“It’s all uncharted waters,” Mr. Akabas said. “There is no guide to go by.”
Luke Broadwater Contribute to the preparation of reports.