Investors, executives and economists are preparing contingency plans as they consider the turmoil that would result from a default in the $24 trillion U.S. Treasury market.
The U.S. debt limit has been reached and the Treasury Department is finding ways to save cash. After it runs out of maneuvers, what once seemed unfathomable could become reality: The United States defaults.
What happens next?
The far-reaching effects are hard to fully predict: from shock waves in financial markets to bankruptcies, recession and potentially irreversible damage to the nation’s long-held role at the center of the global economy.
The probability of a default remains low, at least based on opposing lawmakers’ assurances that a deal will be done to raise or suspend the debt limit and the long odds implied by trading in certain financial markets. But as the day approaches when the United States begins to run out of cash to pay its bills — which could be as soon as June 5 — investors, executives and economists around the world are gaming out what might happen immediately before, during and after, hatching contingency plans and puzzling over largely untested rules and procedures.
“We are sailing into uncharted waters,” said Andy Sparks, head of portfolio management research at MSCI, which creates indexes that track a wide range of financial assets, including in the Treasury market.On the cusp of default, a ‘horror scenario’ comes into view.
Some corners of the financial markets have already begun to shudder, but those ripples pale in comparison to the tidal wave that builds as a default approaches. The $24 trillion U.S. Treasury market is the primary source of financing for the government as well as the largest debt market in the world.
The Treasury market is the backbone of the financial system, integral to everything from mortgage rates to the dollar, the most widely used currency in the world. At times, Treasury debt is even treated as the equivalent of cash because of the surety of the government’s creditworthiness.
Shattering confidence in such a deeply embedded market would have effects that are hard to quantify. Most agree, however, that a default would be “catastrophic,” said Calvin Norris, a portfolio manager and interest rate strategist at Aegon Asset Management. “That would be a horror scenario.”A missed payment sets off a trading frenzy as markets begin to unravel.
The government pays its debts via banks that are members of a federal payments system called Fedwire. These payments then flow through the market’s plumbing, eventually ending up in the accounts of debt holders, including individual savers, pension funds, insurance companies and central banks.
If the Treasury Department wants to change the date it repays investors, it would need to notify Fedwire the day before a payment is due, so investors would know the government was about to default the night before it happened.
There is more than $1 trillion of Treasury debt maturing between May 31 and the end of June that could be refinanced to avoid default, according to analysts at TD Securities.
